Markets Expect Inflation, the Fed Doesn’t but Who’s Right?

March 23, 2021 at 03:24 PM

The US 5-year Breakeven Rate just hit 2.65%. The last time it hit this level was in 2006 when the US was in the middle of a massive housing bubble and oil was on its way to 150 USD per barrel.

Another inflation scare comes from US yields, which have been roaring higher recently, and the 10-year yield climbed to 1.75%. Last seen in January 2020.

Additionally, most commodities are in steep bull trends, signaling higher prices are here to stay. 

Traders and investors are buying some new, untraditional assets, such as cryptocurrencies. The most famous one, Bitcoin, is up more than tenfold since its March 2020 lows. All the markets are screaming inflation is coming. Investors are buying hedges against inflation, but the Federal Reserve (Fed) believes inflation won’t even hit 2% for three more years.   

“[Cryptocurrencies] are more of an asset for speculation, so they’re not particularly in use as a means of payment. It’s more a speculative asset. It’s essentially a substitute for gold rather than for the dollar.” said Fed Chair Jerome Powell said on Monday.

So, if gold usually goes higher when inflation rises, and now bitcoin is on the run, what does that tell you? Everyone excepts higher inflation except the Fed. 

Most of the time, the market is right, and the Fed is wrong. The central bank is reactive instead of proactive. We think that the Fed has it wrong this time as well, and inflation will overshoot their official 2% target sooner rather than later. 

What happens next? Well, the Fed should start tapering quantitative easing and raise rates, but that would pop the bubble in equities. The bank is stuck in a tricky situation. Not doing anything will lead to uncomfortably high inflation, while doing something could lead to a crash in the stock market. The show is just beginning, there will definitely be more to come. 

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