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Global Markets See Inflation Breaking Out to Multiyear Highs

Bloomberg logoBloomberg 2/8/2021 Elizabeth Stanton, Stephen Spratt and John Ainger

(Bloomberg) -- Global markets from U.S. and European bonds to stocks and oil are sending a clear signal: inflation is finally coming back.

The market-implied pace of U.S. consumer-price increases briefly accelerated to the fastest since 2014, and 30-year Treasury yields temporarily topped 2% for the first time in a year as rising expectations for an economic recovery fueled an oil rally. Over in Europe, a swap-market gauge of future inflation is close to its highest level since 2019.

Treasury Long Bond Reaches 2% Milestone as Global Yields Awaken

The S&P 500 index of U.S. equities has notched fresh highs, while the Stoxx Europe 600 Index built on its best weekly gain since mid-November. Brent crude futures rallied more than 1% on Monday, adding to last week’s 6.2% advance. It’s all coming ahead of a report Wednesday that’s forecast to show U.S. consumer prices rising at a quickening pace.

The market moves signal that investors are more bullish on inflation than they have been for years, betting on the global economy bouncing back as huge fiscal stimulus programs spur demand and the vaccine rollout gathers pace. That’s causing a dramatic repricing of bonds most sensitive to rising prices, raising longer-term borrowing costs.

chart: 10-year inflation breakevens hit widest levels since 2014 © Bloomberg 10-year inflation breakevens hit widest levels since 2014

“It’s hard to resist this reflation trade at the moment,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG. “With policy all one-way and U.S. refunding coming up this week, we may require some more concessions.”

Breakeven Rally

Of course, for central bankers, there’s good inflation and bad inflation. A shortage of the chips that fuel everything from smartphones to cars and TVs could be an early indicator of problematic price rises on the horizon, but for now markets aren’t differentiating.

The U.S. 10-year breakeven rate -- the yield difference between the benchmark Treasury note and its inflation-protected counterpart -- touched 2.216% Monday before retreating, according to data compiled by Bloomberg. The gauge broke above 2% this year amid expectations of a successful rollout of coronavirus vaccinations and a U.S. stimulus package.

Read more: Yellen, Summers Spar About Overheating Risk in Stimulus Plan

Other key reflation metrics were also on the move Monday, with the Treasury curve hitting the steepest levels since 2015 and oil prices climbing. U.S. inflation figures this week are projected to show consumer prices climbed last month at a 1.5% annual pace, the fastest since March, according to a Bloomberg survey of economists.

Price pressures within the commodity and goods sector may stem more from pandemic-related supply issues than economic confidence and demand, meaning this could peter out once equilibrium returns. Equally, it has the potential to generate the type of inflation that isn’t so easily corralled by tweaks to monetary policy should it show signs of breaking out.

The Federal Reserve targets an inflation measure that historically has trailed the rise in the consumer price index by about 40 basis points on average, suggesting that the breakeven rate needs to reach about 2.40% to express confidence that officials will reach their goal.

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The bond-market inflation gauge has climbed from a low of less than 0.5% last March, when pandemic-related turmoil rocked markets. It has since advanced for nine of the past 10 months, first supported by a combination of aggressive monetary easing from the Fed.

In recent months, the breakeven rate also drew support from Covid vaccine-related developments and Democrat Joe Biden’s victory in the U.S. election, which lifted expectations for a more-generous fiscal stimulus package. Oil prices rallying to a one-year high amid tightening global supply and an improving outlook for demand has given a further boost to inflation expectations.

Europe, U.K.

In Europe, five-year, five-year inflation swaps -- a gauge of expectations for price rises over the next decade -- closed at 1.36%, not far below the highest closing level since May 2019. The reflation trade is also driving interest-rate swaps -- with the 30-year rate jumping 10 basis points last week, the most since August.

A possible new government in Italy under former European Central Bank President Mario Draghi is helping to boost economic prospects there.

chart: A favorite trade among strategist community is paying off © Bloomberg A favorite trade among strategist community is paying off

And in the U.K., investors have priced out the chance of the Bank of England cutting interest rates below 0%, with the nation’s vaccine program rocketing along.

“Inflationary moves are the right moves,” said Peter Chatwell, head of multi-asset strategy for Mizuho International Plc. “When economic growth accelerates and goes above trend, that is when the inflation signals will really start flashing red.”

(Updates with U.S. CPI report ahead.)

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