Summary
Inflation expectations are knocking on the ceiling, threatening to finally break out above the best levels of 2017. But, long-end yields have tended to drop in the days following past hikes.
Comment
Options markets have become believers in headline inflation running above 2.0% for the next two through 30 years. Inflation swap caps/floors are our preferred measure of inflation expectations. The odds headline CPI runs above 2.0% year-over-year for the next two to 30 years are all above 2-to-1.
The clincher remains investors fully pricing in headline CPI running above the 2.5% year-over-year needed to produce core inflation above 2.0% year-over-year. The ratios between inflation swap caps and floors with a strike of 2.5% are attempting to break above their recent highs in early 2017.
A decisive breakout and approach of 1-to-1 odds is needed to signal a closing gap between anchored market-based rate hike timing (2.5 hikes next 12 months) relative to the Federal Reserve. We believe the chart below is one of the most important to nearly all asset classes heading towards the next hike in December 2018.
The previous seven hikes in this tightening cycle since December 2015 have NOT been the impetus to higher long-end Treasury yields. In fact, U.S. 30-year bond yields have dropped during six (86%) of the seven hikes over the ensuing five trading days by a median of -4.2 bps. Bullish conditions have persisted for approximately a month with yields falling on median nearly -15 bps.
The U.S. 5-year 30-year yield curve has always flattened the day after each hike by a median of -3.0 bps. Flattening has persisted for the ensuing month-plus.
You do not need me to post yet another chart showing U.S. financial conditions as easy. But, consumers are showing yet another revival in credit demand as measured by Google search trends. We measure six-month changes (seasonally-adjusted) in the popularity of commercial lending, credit cards, debt management, and home financing.
