Inflation Pickup Imperils No-Volatility Bubble: Chart of the Day

The Federal Reserve’s lower-for-longer interest rate stance is spurring stocks and bonds as volatility subsides. It’s also fueling inflation expectations that threaten to bring asset prices tumbling down.

The CHART OF THE DAY shows the MSCI All-World Index of equities soaring to unprecedented levels and Bank of America Merrill Lynch’s Global Broad Market Index of bonds climbing as traders’ expectations for exchange-rate swings, measured by Deutsche Bank AG’s foreign-exchange volatility index, plunged with Fed Chair Janet Yellen saying rates are likely to stay near zero “for a considerable time.”

The lower panel tracks the five-year break-even rate, or the difference between yields on U.S. benchmark notes and similar-maturity Treasury Inflation Protected Securities. The gauge touched 2.12 percentage points yesterday, the highest since May 2013. U.S. consumer prices rose 2.1 percent in the year ended May, the most since October 2012. Traders see a 45 percent chance policy makers will raise rates by June 2015, up from 35 percent at the start of the month.

“With FX volatility at record lows, you’re seeing all manner of stretch for yield,” said Greg Gibbs, Singapore-based head of Asia-Pacific markets strategy at Royal Bank of Scotland Group Plc. “If there’s any evidence that the Fed is going to be moving rates higher sooner, the impact on markets would potentially be quite severe.”

Yellen, who became Fed chair in February, last week dismissed an increase in the consumer-price index, calling the data “noisy.” New York Fed President William C. Dudley said June 24 that he “wouldn’t put too much weight” on expectations for a mid-2015 rate rise. Economists estimate data today will show the Fed’s preferred measure of price gains, the personal consumption expenditures price index, rose the most since October 2012 last month.

The MSCI global stocks index has gained 22 percent in the past 12 months, and touched a record high last week. The Bank of America data show bonds on pace for an 8.6 percent return this year that would be the best annual performance since 2002.

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