Wall Street bets on inflation are beginning to shift down a gear


There was a temporary victory for a Federal Reserve that’s under constant attack: Wall Street inflation bets are finally cooling from historic highs.

The derived expectations for price growth over the next ten years are falling, the boom in value stocks is reversing and the supercycle in industrial commodities is easing.

These are telltale signals that the great inflation trade of 2022 is likely to peak – a regime change that threatens to disrupt the cross-asset trading game while challenging naysayers like Bill Ackman.

The Fed’s tightening campaign is beginning to tame the red-hot economic cycle as tighter financial conditions take a toll on consumers and businesses through higher borrowing costs and lower stock prices. At the same time, the boom in goods consumption ends with the build-up of inventories at major retailers.

“US inflation is probably about to peak,” said Seema Shah, chief global strategist at Principal Global Investors. “Consumers are shifting from goods to services while aggregate demand is also slowing, so price pressures on core commodities are becoming increasingly deflationary.”

Yet seemingly forward-looking markets have not done a good job of predicting price trends throughout the pandemic era. Markets have called inflation peaks before, only to be disappointed. Most recently, US inflation beat forecasts in May, confusing economists and equally preparing markets for a slowdown.

“Having a string of positive surprises over the past 12 months and at least one previous ‘peak inflation event’ earlier in the year, could this one prove more realistic and durable?” Emmanuel Cau, head of European equity strategy at Barclays, wrote in a note to customers.

What may have changed this time is consumer reaction. High prices are beginning to change their behavior and discourage them from making big purchases that have boomed after the pandemic. And large retailers are faced with a build-up of unwanted inventory.

All of this means that breakeven inflation rates for both 5- and 10-year government bonds have fallen back to levels before Russia’s invasion of Ukraine in February pushed up wheat and energy prices. The five-year breakeven point for inflation-linked government bonds has fallen to around 2.8 percent, suggesting that market participants expect the average consumer price index to converge towards the Fed’s inflation target of 2 percent over the next five years.

A commodities gauge has fallen to its lowest level since March, and exchange-traded fund Invesco DB Agriculture Fund’s 1.9 billion ETF investors are exiting iShares TIPS product at the fastest pace since 2013 with two straight quarters of outflows.

Meanwhile, equity managers are rediscovering their love for companies, which tend to outperform in a low interest rate environment versus value stocks, which tend to rise when price expectations rise. Wall Street bets on inflation are beginning to shift down a gear

Fry Electronics Team

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