Inflation Expectations – Underestimating Reality

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Inflation has been conspicuous in its absence for the past ten years. However, an analysis of recent developments in inflation drivers on both demand and supply sides suggests that it is about to make a comeback. But are investors prepared for a sudden, even if temporary, acceleration of inflation?

Inflation breakevens rose sharply in the final quarter of last year: 5-year-in-5-year breakeven rates finished December at 1.96% (compared to 0.85% in March). The normalisation of inflation seems to therefore be priced in. From a valuation perspective, with realised inflation being lower, breakevens even appear to be expensive. However, while expectations about inflation have recovered (grey in our chart) these same breakevens have a habit of undershooting realised levels (in red) during periods of economic recovery. This was the case in 2009, 2012 and 2019. Will it be the same for 2021?


Inflation Expectations – Underestimating Reality
Source: Bloomberg, Unigestion. Data as at 11 January 2021.

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