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Break-Even Inflation Expectations Detached From Reality

Jun. 05, 2020 2:33 PM ETRINF
Stuart Allsopp profile picture
Stuart Allsopp


  • Inflation break-evens continue to price in a low long-term inflation outlook the likes of which we have not seen since the Great Depression despite surging money supply growth.
  • We would not be surprised to see inflation head into the high-single digits towards the second half of the decade as investors balk at the prospect of indefinite deficits.
  • Break-evens have largely shrugged off the strong recovery in inflation-sensitive assets, in particular high-yield credit spreads and yen crosses, suggesting there is room to play catch-up.

U.S. break-even inflation expectations remain unfeasibly low despite the strong recovery in inflation assets globally. Amid a continued rally in gold prices, a recovery in the commodity complex, particularly oil, and a broad-based weakening of the dollar, 10-year break-evens continue to price in a very low long-term inflation outlook the likes of which we have not been seen since the Great Depression.

When it comes to financial markets, particularly these days with oil having recently traded below zero and U.S. tech stocks testing all-time highs despite an unprecedented economic collapse, we cannot rule anything out. However, for inflation to average so far below its long-term trend in the face of massive government debt issuance and Fed monetization seems very difficult to imagine. It is also worth noting that the current riots are intensely inflationary as productive assets are being destroyed and fiscal costs are rising further.

Asymmetric Upside Risks

We entered into a long position on the ProShares Inflation Expectations ETF (RINF) on April 22 which is designed to track 30-year break-even inflation expectations – a market-based measure of inflation based on the difference between regular and inflation-linked Treasuries. The index is up almost 8% since we entered and we continue to see it as a highly attractive risk-reward play given the ongoing rise in debt issuance and money supply. A move in 30-year break-evens back to just 2.0% would result in roughly 15% gains from here.

The 10-year break-even is perhaps even more underpriced than the 30-year, currently trading at just 1.2%. This figure seems incredibly low given the long-term trend of inflation averaging considerably higher. In fact, on a 10-year average basis, the last time consumer price inflation averaged as low as 1.2% was back in 1941 – a 10-year period which included the deflationary depths of the Great Depression during which time the money supply

This article was written by

Stuart Allsopp profile picture
I am a full-time investor and owner of Icon Economics - a macro research company focussed on providing contrarian investment ideas across FX, Equities, and Fixed Income based on Austrian economic theory. Formerly Head of Financial Markets at Fitch Solutions, I have 15 years of experience investing and analysing Asian and Global markets.

Analyst’s Disclosure: I am/we are long RINF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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