Inflation Redux?

Are we going to see a U-Turn?

Last week’s US inflation readings did not allow for further disinflationary euphoria. While one data point doesn’t change the overall market narrative, some pressing questions must be answered. The fear of a second inflation round would indeed set shockwaves across all financial markets were it to materialise. For now, however, markets are shrugging it off and pushing out rate hikes, as the below chart for the US highlights.

The yellow curve is the SOFR OIS curve as of the start of this year, vs. the blue curve, which is the current curve.

Source: Bloomberg

How worried should we be that the seemingly entrenched disinflationary force will suddenly stop or even reverse?

The IMF has studied 100 inflation shocks over the last 50 years, and I’d recommend you read the paper if you have the time. It makes for a rather hawkish read, with only 60% of inflation episodes resolving within five years.

The remaining 40% of occasions were typically the consequence of a premature celebration by the respective central banks. Sound familiar?

Let’s explore this in more detail.