Chart of the Day!

Source - Duetsche Bank

This chart arrives at a particularly intriguing moment.

Let me quickly explain the chart first.

A 5-yr inflation swap is a financial instrument used to hedge or speculate about future inflation. It reflects the market's expectation of the average inflation rate over the next five years.

When inflation swap rises, it basically indicated a potentially high inflation environment. Now in the Chart we can see the biggest 5 week rise in the swap since early March 2023.

Why is it interesting now?

Because FED is at a cusp of pausing a long interest rate upcycle and starting interest rate cuts (which it already did by 50 bps). The cut is done to reduce the high-interest rate pressure on the economy and not letting it slide into recession. But this chart might put FED in a pickle as they believe the Inflation is now under control and economic growth should be the next priority. But if that's not the case, this will attack FED on all fronts with tightening in labor market, lower consumption, high interest rates and a high inflation.

Before panicking we need to understand that this is a market-based indicator built on expectation. For instance, during 2008 financial crisis, inflation swaps predicted much higher inflation rates than what was realized. But it is an important observation which cannot be completely overlooked.

#FED #Inflation