The 5y5y inflation swap indicator? It's out of order
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THE 5Y5Y INFLATION SWAP INDICATOR? IT’S OUT OF ORDER
The 5-year, 5-year forward inflation swap is regarded as one the best market-based gauges of medium-term consumer price dynamics.
However, it looks like it hasn’t been doing its job lately.
Deutsche Bank strategists recall that, since late January, 5y5y U.S. inflation has traded in the tightest 6-month range on record, with swaps fluctuating between 2.53% and 2.67%.
"This is striking given the inflation overshoot of recent years and questions around whether trend inflation is likely to be higher going forward," they argue.
"One interpretation of the tight range is that Fed policy over recent years has actually bolstered their credibility on inflation," they say in a research note.
DB analysts reckon that an alternative explanation is that this measure doesn’t actually trade with views on 5-to-10-year-ahead inflation.
"Ten years is a long time to hold the position, and market liquidity and other factors prevent related arbitrage opportunities from being exploited," they add.
"Both explanations have merit, but we lean towards the latter. And we maintain our long 5y5y inflation swap recommendation."
(Stefano Rebaudo)
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