Global Rates: DM inflation markets under higher real rates

Frida Infante (0:03)

Hi, and welcome to At Any Rate, JP. Morgan's Global Research Podcast, where we take a look at some of the drivers behind the biggest trends and themes across fixed income currencies and commodity markets. I'm Frida Infante from the European Rate Strategy Team, and I'm joined by Harry Downie from our US Rate Strategy Team. Today, we're talking through inflation and inflation markets across the US, the Euro, and the UK. We're recording this on the 24th of September, and our comments today are based on the latest published research available on JP. Morgan Market. So, let me let the scene.

This month, this theme is really about being tactical, especially at the front end of inflation curves. Ten-year break events are higher since our last month's inflation outlook, but that move has mostly reflected the sell-off in intermediate nominal yields. Front-end inflation swaps, meanwhile, have been a lot more range-bound. At the same time, the inflation forecast profile has moved higher. In the euro area, our economies now see headline inflation rising close to 4% by the end of this year, mainly because of energy. And core inflation, both in the US and the euro area, is expected to hover around 2.5% into next year.

The other big story is real yields. Ten-year real yields in both the US and Europe have pushed to multi-year highs. But when you break that move down, a lot of it has come from the front-end of real rates, which really speaks to the more resilient growth backdrops, to gear inflation and higher central bank rates expectations. So with that backdrop, Harry, let's start with the US.

A month ago, when we last spoke, the September meeting for the Fed was not a forgotten conclusion. We now have had them deliver a hike and have them priced for almost another four by the end of 2027 What's been driving the move and how is it impacting inflation?

Harry Downie (1:45)

Yeah, you're right, Frida, and thanks for having me. A lot can happen in a month. We have now in the US, five, 10, and 30-year real yields back to levels. We haven't seen since the GFC, we've had the sharpest rise in 10-year real yields since October 2023, the last time 10-year nominals broke 5%.

So a lot is changing, but I think you pointed to it clearly in the intro. That's largely changing because of risks to real growth rather than inflation. Despite us currently being above $100 on brand core CPI, surprising to the upside, the notable shift came in the Fed's September projections, where they saw that the risk growth would now skew to the upside. This obviously led the Fed to hike and also led to a more hawkish delivery through the SEP and also through the commentary and press conference thereafter. It's interesting because it's also been confirmed in recent data. Retail sales were stronger than expected, particularly for the control group, which is the closest proxy to real growth. Jobless claims, we got new data today, continue to remain near their lows. The September flash PMIs rose the highest level in five years yesterday, equivalent to growth of around 5 percent, which skews the risk to our forecast, which are in the high freeze for this quarter, to the upside.

The important thing for the Fed and the reason why they delivered a more hawkish hike is because not because inflation risks are changing, but now because their objectives are in less conflict than they appeared earlier in the year with growth holding out. The committee has more room to address the inflation side of their mandate, particularly given the chair's own comments, but they're struggling to see that financial conditions are restrictive. Now, and that for us has led us to reprice our own forecasts, not in the inflation market, but in the nominal rate market where we think the market can price closer to 100 basis points of cumulative tightening. Of course, above that now.

For inflation markets, the reprising has been a lot more benign. The story has been much more real rate one than a break even. I think that's reflective of a more hawkish Fed, but not one that we get to point out that they're materially altering the outlook for inflation going forward.

Frida Infante (4:22)

It's clear growth risks are rising. Is this entry over inflation?

Harry Downie (4:27)

Not necessarily. The growth data clearly skew to the upside like I mentioned, but if we think about inflation markets, I'll point out a few things. One is the August CPI report.

Two is the underlying trend, and then three are the risks around those views. Firstly, on the August CPI report, it came in hotter than expectations and people came in at 29 basis points, which was above economist consensus, which was closer to 20 basis points.