One area of the U.S. bond market is showing traders expect a rise in inflation after the Federal Reserve kicked off its easing cycle with a large interest-rate cut amid a still-growing economy, according to Deutsche Bank Research.
The five-week change in five-year inflation swaps marks the biggest jump in inflation expectations since March 2023, right before the collapse of Silicon Valley Bank, a chart in a Deutsche Bank Research note shows. The chart measures the change in basis points.
“If the economy is in decent shape, a sizeable easing cycle surely increases inflation, all other things being equal,” Jim Reid, head of global economics and thematic research at Deutsche Bank, said in a note emailed Monday.
But it’s not just the Fed’s decision to cut its benchmark rate by 50 basis points in September to start its easing cycle that changed the outlook on inflation and rates over the last few weeks, said Reid. He also pointed to expectations for the European Central Bank to ease its monetary policy more aggressively, geopolitical risks and “a potentially large China stimulus” that could turn the prices of oil and other commodities higher, and “generally firm” U.S. economic data.
“This is not to say inflation is out of control but the narrative of a strong economy, a relatively aggressive Fed easing cycle and perfectly behaved inflation sounds more like a Christmas wish list rather than the most likely outcome,” said Reid. While one or two of those economic backdrops can “easily” materialize, getting “all three is going to be tough,” he said.