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Chart of the Day: US inflation expectations

With the world’s central banks watching inflation and inflation expectations incredibly closely, one chart many have their eyes on right now is US five-year inflation swaps. There seems little doubt that if inflation expectations are headed lower, the need for an aggressive response from the Federal Reserve increases. This will have a greater effect on rate cut expectations, bond yields, the USD, equities and gold.

Chart of the Day - July 18, 2019 - US five-year inflation swaps

In the institutional world, financial institutions can trade certain derivatives and bond instruments to actually trade inflation expectations over a period. As I’ve looked at here, US five-year inflation swaps give us insight on how the market sees the US inflation breakeven rate over the coming five-years.

The fact remains, central banks understand that inflation expectations often influence actual inflation in the future. Consider: If enough people believe apartments in a particular suburb are going to fall, the buyers stand aside, and prices often fall as the sellers meet the market.

As we can see, US five-year inflation expectations recently had a move higher into 2.14% but have started to roll over, where we can see this dropping six basis points (bp), or 0.06ppt, in US trade. There’s little doubt this move has been responsible for the rally into US$1,426 in gold. We can also see the probability of a 50bp cut in the 31 July FOMC meeting increasing to 34%. If inflation expectations head back into 1.90%, then it’d weigh on the USD and push gold higher. That’s a chart very much on the radar.

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