The 10-year US breakeven inflation rate jumped to 2.52% on Friday, up from 2.38% at the start of the week, and from a low of 2.12% on January 18th. Inflation expectations (as measured by TIPS) may be reacting to suggestions that the Federal Reserve should change its inflation target.
Equity bulls would benefit if this scenario pushed up inflation expectations and lowered real yields. But this is unlikely to be the case: a 3% target could be viewed as an attempt to inflate away the debt. This would damage not just the Central Bank’s credibility, but potentially the Treasury’s too, raising the term premium.
Bond markets are already on tenterhooks. The UK Gilt market is giving a clear warning. The Governor of the BoE, Andrew Bailey, has attempted to push back against market rate expectations. But the long-end of the curve is still selling off: a 30-year UK Gilt (4.23%) now yields more than on the day of the mini-budget (4.01%) and 0.33% over a same duration US Treasury.
Globally, labour markets remain far too tight. The “record” labour shortage at hotels and other tourism-focused businesses poses further upside risks to the inflation forecast in Japan, as it prepares for a wave of new arrivals from China. More Japanese workers are now looking to move abroad to take advantage of higher pay and shorter hours.
