Inflation swaps show confusion and fear regarding inflation
Investors aren't sure whether they should be scared of inflation or deflation, but they're worried about both.
The FT today writes about rising option premiums for protection against pricing extremes in either direction:
The price of options linked to inflation swaps shows that investors are paying up to protect against extreme scenarios at both ends of the spectrum. The probability of price declines in the US has more than quadrupled to 7.5 per cent since the start of this year, those options show, even while the chance of annual inflation running hotter than 2.5 per cent over the next half decade has almost doubled to 8 per cent, according to analysis by NatWest Markets.
It makes sense.
Central banks are reaching deeper into their toolkits than ever before and there are two outcomes: 1) It doesn't work. That would leave economies in a long-term environment of low or no growth and would mean disinflation. Or 2) It works. The problem in that case would be the difficulty of reigning in inflation, especially when Powell could tip a shift towards average inflation targeting on Thursday.
JPMorgan Asset Management strategist Karen Ward adds this, via the FT.
"On the one hand, central banks are under tremendous political pressure to keep rates low, and governments have lost their fear of debt," she said. "But once furlough schemes come to an end you can see a scenario where companies say 'you can come back on 80 per cent of your pay, or we let you go'."
The outcome of the great inflation debate will set the table for the decade ahead.