The Grumpy Economist

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Inflation options? Posted: 25 Mar 2021 08:28 AM PDT   From Torsten Slok at Apollo. Torsten explains Current pricing for caps and floors shows that the market sees a 30% probability that inflation will be above 3% for the next five years, and a 5% probability that inflation will be below 1%, see chart below. A similar worry about high inflation can be seen in 5-year breakevens, currently trading at 2.5%, the highest level since 2008. A perpetual inflation worrier, I habitually confront the fact that bond prices don't signal inflation. I am forced to point out that they never do -- interest rates did not forecast the inflations of the 1970s, nor the disinflation of the 1980s. And I say inflation is unforecastable, a risk like a California Earthquake.  But for once there does seem some inflation risk in asset prices.   These are option prices. The main forecast remains subdued inflation. But these option prices are pointing to a larger chance that inflation does break out. More risk, not so much a sure thing. Also, it's not really screaming -- after all, we're about at the prices of July 2018. In Torsten's view, despite these prices,  Five years of CPI inflation above 2.5% or 3% is in my view extremely unlikely.

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