Markets Start to Bow to the Inflation Reality
Bond breakevens are moving up, though the message they are sending should be treated with caution.
This may not go out on its own.
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At last we have acceptance that the current wave of inflation is more than a blip. Markets are showing that in the clearest way they can, by bidding up breakevens, or the implicit rate of inflation they are forecasting when inflation-linked and fixed-income bond yields are compared. As the year dawned, estimates for the next two, five and 10 years were all perfectly positioned at almost exactly 2%. Since then there has been a scare, a partial recovery, and now another scare.
That is concerning, and seems a reasonable reaction to the gathering evidence that inflation won’t go away without some effort to extinguish it. However, even if higher breakevens are rational as far as they go, there is still reason to doubt how much weight we should put on them. To start with, they move in line with fluctuations in the oil price. This has always been true, but is particularly so at present. The following chart shows year-on-year percentage changes in oil and the 10-year breakeven: