Our Inflation Monitoring Summary

Table 1.1 - Different inflation measures and Bond yields

As of May 2022, CPI inflation is running at a YoY rate of 8.26% and a 3m annualised rate of 11.33% (Table 1.1). The current reading has remained almost unchanged from the previous month’s value of 8.54%. Seasonal effects are weighing on the current high inflation readings, which will likely continue being felt until the end of the summer.

In the senate committee on Housing, Banking and Urban Affairs, on the 3rd of March, he told the committee to expect rate increases ahead in line with the previous plan to tackle rising inflation. He also noted the implications for the U.S. economy from the Ukraine war are “highly uncertain”. The Fed Chairman additionally hinted on his commitment to focus on price stability as his main target in the coming months, and that he expects inflation to lower as a result of the planned monetary policy actions.

On Wednesday the 4th of May, the Fed started its rate-rising cycle by raising the Federal funds rate by 0.5% to a range of 0.75%-1%. Additionally, the Fed Chairman hinted at multiple 50-basis point rate hikes ahead to tackle rising prices. The Fed plan to tackle inflation includes a phased reduction of its balance sheet by not reinvesting part of the proceeds from maturing bonds.

Currently, bond-market expectations for future inflation are even more sanguine than the recent change in language by the Fed Chairman, as illustrated by the 10y breakeven rate of 2.88% (Table 1.2). Market participants remain unfazed, even with the jump in CPI from 5.35% in November 2021 to this month’s 8.26%. Current real yields on the 10y bond are close to -5.5% which are an extraordinary test to investors’ patience; they still haven’t even adjusted their expectations towards persistent inflation.

We continue to be of the opinion that the current inflationary pressures are mostly a monetary phenomenon, and the impact of supply-chain disruptions is a short-term confounder. Our monthly report will monitor closely the latest developments in current inflation, inflation expectations, and monetary factors that impact inflation, to give our clients an advance warning and up-to-date monitoring of inflation.

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From our monetary analysis we come to the conclusion that we need to expect higher levels of inflation going forward than the 2%-2.5% target defined by the Fed. We show that a likely scenario is one where inflation averages about 7% (or more) in the next 5 to 10 years.

Why is our inflation monitoring report important?

-> Inflation is a hot topic at the moment. After lying dormant since 1990, it sems as though inflation has made an unexpected comeback. If in the last decade, deflationary forces seemed to dominate the macroeconomic landscape, the Covid-19 pandemic brought about significant political and social changes.

-> Inflation is a key economic variable in the economy. It has a large impact on the bond market which through the setting of rates of interest moderates the economic growth. Bond investors and central bankers all monitor inflation and bond yields as the key barometer for the status of the economy.

-> Due to this position of the US in the global economy, we believe that future inflation in the US will spill over to the rest of the world, as countries will need to increase their money supplies in order to keep their exports competitive with the US. Inflation in the US does not mean that the USD will decline relative to other currencies but mostly relative to real assets whose supply is fixed or slow growing.

Who would benefit from our report?

-> Global investors who have exposure to the bond market.

-> Industry Sectors or activities that have interest rate exposure (Banks, Real Estate, Leveraged Buyouts, etc).

-> Corporations or investors who are exposed to commodities.

-> - Investors or asset allocators who are uncertain of how to quantify risks and opportunities due to different inflation outcomes in the coming decades.

-> Risk managers who want to measure inflation risk and perform educated guesses on different inflation scenarios.