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- In the past few months, a rising amount of investors have been concerned that the inflationary pressures in most of the economies will last longer than what policymakers currently expect.
- They often refer to the US 5y5y inflation swap - a market-implied measure of long-term inflation expectations - which has risen significantly in the past year and currently trades at 2.40% (way above Fed's 2-percent target).
- However, we have seen that in past cycle, the 5Y5Y inflation swap has been very sensitive to changes in front-month futures of oil and equity prices.
- The chart below shows the strong co-movement between the annual change in 5Y5Y and annual change in WTI (front month futures).
- In theory, strong moves in equity and oil prices should not impact LT inflation expectations as timely monetary policy readjustments are there to offset those shocks.
- Hence, even though the 5Y5Y inflation swap keeps rising in the coming months, it may not reflect anything about LT inflation expectations.