Market-based inflation expectations in the eurozone and the US have diverged for the first time in over two years, as firmer job markets help lift US inflation prospects just as a rise in the euro suppresses price pressures.
The European Central Bank’s preferred gauge of long-term inflation expectations, the five-year, five-year breakeven forward — which measures where the market expects 2026 inflation forecasts to be in 2021 — is around 1.45% and well below the ECB’s 2% target.
It remains close to record lows around 1.35% hit in February even after aggressive monetary stimulus and a recovery in oil prices, indicating low inflation expectations continue to favour lower government bond yields in the region as well as further action from the central bank.
In contrast, similar measures in the US have steadily risen since February to above 2% as oil’s rebound and signs of labour market strength fuel a view that domestic inflation is accelerating.
Investor perceptions of where inflation in the US and euro area have started to change in early March, having moved closely together since late 2013.
The US bond market’s gauge on investors’ inflation outlook in 10 years hit its strongest level since early August on Thursday due to higher oil prices and data showing faster than forecast price growth in the first quarter.
But oil, up roughly 70% from January lows, has not had the same impact on eurozone inflation expectations.
One reason for this is a rally in the euro, which has gained almost 5% versus the dollar this year and is up 2% in trade-weighted terms.
“There has been a substantial move in the euro, which should dampen inflation in the eurozone,” said Patrick O’Donnell, investment manager at Aberdeen Asset Management.
HSBC fixed income strategist Theo Chapsalis said technical factors, increased supply of long-dated inflation linked bonds and still low headline inflation were also behind the low market inflation expectations for the eurozone.
While US unemployment rates have fallen to just above 5% the eurozone’s unemployment rate remains above 10%, adding to the low inflation environment in the region.
Many investors want to see headline inflation go up before they put on bigger positions in the forwards market, said Chapsalis.
Eurozone April inflation was estimated at -0.2% year-on-year, the European Union’s statistics agency said yesterday.
For others, a decoupling of US and eurozone expectations reflected concerns that the ECB’s 1.5tn euro quantitative easing package was insufficient to boost inflation.
“There is a view that the ECB won’t be able to manufacture enough inflation to fulfil its mandate,” said ING senior rates strategist Martin Van Vliet. “But I’m not willing to throw in the towel yet.”