The three components needed to foster an inflation premium within sovereign yields and risk assets were incrementally met beginning in early October:
- 50% of economies growing above trend
- 50% of commodities producing YOY gains
- 50% probabilities headline CPI will average above 2.0% YOY
The blue wave has ignited a jump in nominal Treasury yields, while real yields refuse to follow along. The Federal Reserve’s new AIT framework suggests dovish policy will persist in the face of rising inflation (if it really happens). TIPS breakevens have already produced record high Sharpe ratios, but have room to run according to risk assets.
The TIPS breakeven curve has inverted offers one hint of caution. Inversions have always been a signal of peaking inflation expectations. This time will have to prove different with the Federal Reserve remaining committed to full employment and AIT. Investors should prepare for this curve inversion to persist much longer than past episodes.
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