(Bloomberg) - The bond market is starting to grapple with the risk that inflation could be tough to rein back.
That’s the message from the sharp rise in a market gauge of price expectations over the next decade, one meant to factor out near-term volatility. The five-year five-year forward breakeven jumped to its highest since 2014 on Tuesday, just days after a straight 10-year measure notched a record in Bloomberg-tracked data going back to 1998.
Market inflation expectations are key to whether or not it becomes self-perpetuating, as people start to factor higher prices into decisions further into the future.
“We see a risk of inflation expectations becoming unanchored in the medium-term, causing central banks to raise rates sharply,” wrote BlackRock Investment Institute strategists including Alex Brazier and Wei Li in a note Monday. “We prefer developed equities in this inflationary environment.”
With the highest inflation in 40 years and a surge in energy prices, central banks may not be able to afford to stay behind the curve in subduing price pressures.
Traders are penciling in seven hikes from the Federal Reserve this year, starting with an almost-certain 25 basis-point hike on Wednesday as it kicks off a multi-month campaign.
Read more: Fed to Start Rate Hikes With License to Turn Aggressive Later
That said, expectations could ease if the latest retreat in oil prices is sustained, with West Texas Intermediate futures dropping back below $100 a barrel on Tuesday.
The unpredictable course of Russia’s invasion of Ukraine and the resurgence of Covid-19 in China, the world’s biggest crude importer, are keeping the market volatile.
“There is definitely a risk” of inflation getting unhinged as the war compounds broad-based inflationary pressure, said Priya Misra, global head of rates strategy at TD Securities in New York. “Will the Fed be willing to tolerate a recession to get inflation to target? That’s the tough question the market is grappling with.”
(Adds Fed rate hike expectations in sixth paragraph)
By Emily Barrett
