Inflation expectations in the United States are climbing rapidly, with the country's April consumer price index marking a three-year high. Amid concerns over a prolonged war in Iran and volatile price indicators, tensions are rising among central banks in major economies as well as Wall Street investors.
According to the Federal Reserve Bank of St. Louis on Wednesday, the U.S. five-year breakeven inflation rate (BEI) recently recorded 2.69%. The indicator, calculated as the spread between regular Treasuries and Treasury Inflation-Protected Securities (TIPS), has risen from around 2.2% at the end of last year to near 2.7% recently. The Wall Street Journal noted that "the five-year BEI has climbed to its highest level since October 2022," explaining that "this means investors expect average annual inflation over the next five years to settle around 2.7%." The 10-year BEI has also continued its upward trend, reaching 2.5% this month, the highest level since 2023.
Market analysts say that surging international oil prices following the war in Iran are fueling the rise in inflation expectations. Higher inflation expectations are expected to weigh significantly on the Federal Reserve's rate policy as well as on U.S. equities, which have been hitting record highs. In particular, concerns are growing over the possibility of a self-fulfilling prophecy, in which elevated inflation expectations translate into actual price increases. If businesses preemptively raise product prices in anticipation of rising costs, inflationary pressure could spread across the broader economy.
"The equity market will also start watching breakeven inflation rates more closely," said Zachary Griffiths, head of strategy at research firm CreditSights. "Fed policymakers had been able to take comfort from stable market-based inflation expectations, but the mood is clearly changing now."
However, some analysts argue that rising inflation expectations do not necessarily act as a short-term negative for stocks. If nominal interest rates remain unchanged, a rise in inflation expectations lowers real interest rates (real rate = nominal rate - expected inflation), which can stimulate borrowing and consumption by businesses and households.
Some observers also say that the level of inflation expectations has not yet reached a point where it would put serious pressure on the Fed. "If the 10-year breakeven inflation rate climbs to around 2.6%, we would be more concerned," said Gennadiy Goldberg, U.S. rates strategist at TD Securities. "But if the increase is driven by energy prices, it remains uncertain how seriously the Fed will take it."
