IF YOU HAD to pick an emblem of the wild ride that financial markets have been on, it would be Carnival. When the pandemic took hold, its cruise ships were regarded as floating petri-dishes. Yet last April it was able to raise capital, as the corporate-bond market thawed. More recently it raised $3.5bn at half the interest rate that it paid last year. Now all the talk is of pent-up consumer demand and the inflation that will unleash. Carnival’s bookings for the first half of 2022 are above their level in 2019. The company has captured the market zeitgeist once again.
If you can marvel at the speed of the firm’s change of fortune, marvel too at another turnaround. The yield gap between ten-year Treasury inflation-protected bonds (TIPS) and conventional bonds of the same maturity is widely seen as a measure of long-term inflation expectations. These inflation “break-evens” have soared to 2.2% from a low of just 0.5% last March.
Serious people are talking of a return to 1970s-style inflation. In America bumper fiscal-stimulus packages seem to arrive like overdue buses, one after another. They are layered on top of unprecedented monetary easing and a pledge by the Federal Reserve to tolerate inflation above 2% for a while. The case for higher inflation seems more persuasive than it has for years. But break-evens will not tell you a lot about whether it might be sustained. They are too volatile to be a reliable guide.
A jump in annual inflation seems assured. Last spring, when cruise liners were beached, there was a glut of crude oil in storage and in seaborne tankers. The month-ahead price of oil briefly turned negative. A year on, inventories are falling. The price of a barrel of Brent crude has surged past $60. The trend is mirrored in the rising prices of other commodities. That will push up year-on-year comparisons of prices and thus annual inflation. Commodity markets offer a template of what could yet happen in the wider economy: a surge in demand meets constrained supply, leading to inflation.
In the central-banking model, expectations are self-fulfilling: businesses set prices and wages in accordance with the inflation they look ahead to. Yet it would be unwise to put too much faith in break-evens. They often reflect market influences that are only tangential to future inflation. Look at Britain, for instance. Legislation in 2004 obliged pension funds to match their assets to their long-term promises. This in turn spurred demand for long-dated index-linked bonds, and the debt-management office issued lots more of them. Despite this issuance, the demand for inflation protection has over time driven real yields down to unusually low levels and pushed up break-evens.
In America, the oil price appears to have an outsize influence on break-evens. A simple model based on the oil price and the dollar tracks…
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