As US Inflation Expectations Plunge And Converge With Europe’s, Here Is One Way To Trade It

By Francesco Filia, CIO of Fasanara Capital

US Inflation Expectations Closing Gap To Europe’s

In January, surprisingly, US Inflation expectations, as measured by 5y5y forward inflation swaps, plunged closer to European forward inflation rates (within 10bps from 5yr lows).

In stark contrast, the 5y interest rates spread between US Treasuries and Bunds stands near its 5-yr highs, as the FED expects (and is expected) to raise rates, while the ECB contemplates deeply negative interest rates.

As the FED may find it impossible to finalise their plan for 4 rate hikes this year (25bps each in March, June, Sept and Dec, of which ~40% is priced in by markets currently), due to inflation expectations plummeting in addition to recession in US manufacturing, Oil, Commodities, China, EMs etc.. the 5y interest rate differential may have to capitulate and compress over the course of 2016.

Chart: US 5y5y Inflation Forwards vs Eur 5y5y Inflation Forwards (spread in lower panel)