15/4/17: Thick Mud of Inflationary Expectations

The fortunes of U.S. and euro area inflation expectations are changing and changing fast. I recently wrote about the need for taking a more defensive stance in structuring investors' portfolios when it comes to dealing with potential inflation risk (see the post linked here), and I also noted the continued build up in inflationary momentum in the case of euro area (see the post linked here).

Of course, the current momentum comes off the weak levels of inflation, so the monetary policy remains largely cautious for the U.S. Fed and accommodative for the ECB:

More to the point, long term expectations with respect to inflation remain still below 1.7-1.8 percent for the euro area, despite rising above 2 percent for the U.S. And the dynamics of expectations are trending down:

In fact, last week, the Fed's consumer survey showed U.S. consumers expecting 2.7% inflation compared to 3% in last month's survey, for both one-year-ahead and three-years-ahead expectations. But to complicate the matters:

• Euro area counterpart survey, released at the end of March, showed european households' inflationary expectations surging to a four-year high and actual inflation exceeding the ECB's 2 percent target for the first time (February reading came in at 2.1 percent, although the number was primarily driven by a jump in energy prices), and
• In the U.S. survey, median inflation uncertainty (a reflection of the uncertainty regarding future inflation outcomes) declined at the one-year but increased at the three-year ahead horizon.

Confused? When it comes to inflationary pressures forward, things appear to be relatively subdued in the shorter term in the U.S. and much more subdued in the euro area. Except for one small matter at hand: as the chart above illustrates, a swing from 1.72 percent to above 2.35 percent for the U.S. inflation forward expectations by markets participants can take just a month in the uncertain and volatile markets when ambiguity around the underlying economic and policy fundamentals increases. Inflation expectations dynamics are almost as volatile in the euro area.

Which, in simple terms, means three things:

1. From 'academic' point of view, we are in the world of uncertainty when it comes to inflationary pressures, not in the world of risk, which suggests that 'business as usual' for investors in terms of expecting moderate inflation and monetary accommodation to continue should be avoided;
2. From immediate investor perspective: don't panic, yet; and 
3. From more passive investor point of view: be prepared not to panic when everyone else starts panicking at last.

16/10/15: Euro Area Inflation, via Pictet

An interesting chart highlighting the poor prospects for inflationary expectations in both Euro area and the U.S. via Pictet:

5yr/5yr swaps are basically a measure of market expectation for 5 year average inflation starting from 5 years from today, forward (so years 6-10 from today). This is a common referencing point for the ECB technical view of inflation expectations, and as the above clearly shows, we are heading for testing January 2015 lows.

Here’s Picket analysis (comments and emphasis are mine): “In September, headline inflation in the euro area dipped back into negative territory (-0.1% y-o-y) for the first time in six months.

"This weakness must be put into context though as it is primarily due to the steep slide in energy prices. If volatile components (food and energy) are stripped out, core inflation was steady at +0.9% y-o-y. Furthermore, prices of services, which better reflect domestic conditions, rose.

"Nonetheless, falling commodity prices, coupled with the rise in the euro’s trade-weighted value, caused the inflation outlook to worsen. Long-run inflationary expectations, as measured by the break-even swap rate, have been softening steadily since early July and have now reached their lowest level (1.56%) since February this year.

…In parallel, findings from economic and business surveys (PMIs, European Commission surveys) for the third quarter showed decent resilience despite the worries about the Chinese economy. They point to GDP growth of around 0.4% q-o-q in Q3 and Q4.”

Picket projects growth of 1.5% y/y for 2015, “led by domestic demand” that is expected to “continue to benefit from normalisation of the jobs market, subdued inflation, the gradual revival in consumer confidence and an upturn in lending to the private sector.”

In short, sensible view of inflation - low inflation, per Pictet is helping, not hurting the euro economy.

28/8/15: Inflation Expectations: Euro and U.S.

Having earlier posted a chart on Central Banks balancesheets expansion (see here), here is an interesting chart plotting inflation expectations (5yr5yr swaps - effectively markets expectations for 5 years from now inflation average over subsequent 5 years)

The above shows that although there has been an uplift in Euro area inflation expectations over the course of 2015 to-date, consistent with QE carried out by the ECB, the expectations have tanked since the start of Q3 2015 in line with those in the U.S.

More ominously, expectations remain in the territory where neither the Fed nor the ECB are capable of convincingly exiting monetary easing.

While the U.S. expectations are closer to target (at 2.23%) but still weak, Euro area expectations are exceptionally weak at 1.63%. Gotta do some more printing (for ECB) and less talking about tapering (for both the Fed and the ECB)...