Global Rates Weekly: Returning to the old normal

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Global Rates Weekly: Returning to the old normal

Barclays | Global Rates Weekly: Returning to the old normal

In other words, were the data to lead the Fed to reassess its inflation forecast higher to match

the market, it could potentially forecast a larger hiking cycle than the markets are discounting.

FIGURE 6. Markets are pricing in above-target inflation... FIGURE 7. ... and, as a result, a slightly restrictive real policy rate

1y CPI inflation at different forward dates 1y real rates (OIS minus CPI swaps) at different

1.8 forward dates 2.8

2.7 Headline CPI Energy Adj. Ex-energy CPI Ex-energy real rate Energy Adj. 1.7 1.6 2.7

2.6 2.6 1.6 Traded Real rate 2.6 0.2 2.5 2.5 1.5 1.5 0.1 1.5 2.5 0.1 0.1 1.4 1.4

0.1 0.1 1.4 0.2 0.1 2.4

0.1 0.1

2.3 1.3

2.5 1.5

2.2 2.4 2.4 2.4 2.4 1.2 1.3 1.3

1.3 1.3 2.1 1.1

2.0 1.0

1yf 2 3 4 5 1yf 2 3 4 5

years years

Source: Bloomberg, Barclays Research Source: Bloomberg, Barclays Research

Further out the curve, the question is whether all these shifts argue for higher or lower rates. For

instance, one could make the case that an inflation-focused Fed should lead to a lower inflation

risk premium. On the other hand, greater uncertainty about the Fed's reaction function and

potential shortening of balance sheet argue for a higher term premium. We believe the latter is

likely to be a bigger driver.

Far-forward inflation breakevens have already tightened to reflect the inflation focus, and

further room to tighten seems limited. 5y5y CPI swaps are 2.35%, well below the recent highs

of 2.5% and not far above the recent lows of 2.3%. Figure 8 shows that compared with measures

of inflation expectations, 5y5y CPI swaps look tight.

FIGURE 8. The inflation risk premium is already quite low, suggesting limited room for further

compression