News & Insights

One-year inflation breakevens, a measure of near-term price expectations, rose sharply from 2% at the start of the year to around 5% but have since fallen back to 2.7%. Five-year breakevens have risen to a modest 2.6%. The rise in the 10-year breakeven rate has followed a similar path. Markets are treating current inflation pressure as a temporary development rather than a lasting structural change.

The Federal Reserve’s long-standing concern has been that inflation expectations become unmoored, leading businesses and consumers to begin pricing in persistently higher costs. This would transform what might be a temporary condition into a self-reinforcing economic problem. That is not happening. Bond markets are signaling that investors view current inflation as tied to specific, near-term circumstances, with limited expectation it will last.

On the manufacturing side, the Institute for Supply Management (ISM) data released June 1 came in strong, suggesting the Middle East conflict is minimally disruptive to U.S. industrial production and orders. The Services index, which is more consumer-facing, are less robust, having fallen since the onset of the conflict. The ISM price indices for both manufacturing and non-manufacturing have seen a large jump, to 82.1 and 71.3 respectively. These figures mark the highest levels in nearly four years, indicating that input costs for businesses are rising quickly. The producer price index shows a similar picture. If energy prices remain elevated, they will contribute to even higher core consumer prices. To the extent that cost pressures are absorbed by producers rather than flowing through to consumers, the inflation picture will remain more contained. Many companies have been hesitant to pass on costs citing consumer resistance and reluctance to accept higher prices. The longer input prices are elevated, the greater the pressure on companies to pass these rising costs on to consumers.

Higher food prices, which are up 0.7% month-over-month, are linked to rising energy costs, including other indirect inputs such as transportation and animal feed for meat. Fertilizer supply presents a slower-moving risk to consumers. Roughly 40% of global nitrogen-based fertilizer comes from the Persian Gulf region, and that supply is currently frozen. Fertilizer is necessary for the planting of multiple crops that have an imminent growing season. Resumption to a normal flow of fertilizer will be unpredictable following the opening of the Strait of Hormuz as plants restart and repairs begin for some of the damaged facilities in the Middle East. This will continue to affect food supply and prices.

Similarly, the disruption of helium supplies from Qatar is a concern for semiconductor manufacturing. The supply shortage has created uncertainty, though many facilities have stockpiles and recycle helium at production facilities providing a meaningful buffer against supply shocks. While a longer-term closure of the Strait of Hormuz would likely have production consequences for chip manufacturers, they have yet to indicate that it has become an imminent problem.

This cluster of near-term, supply-driven pressures is primarily attributable to higher petroleum prices. Such developments have yet to shift long-term inflation expectations, but if the Strait continues to be closed, higher energy prices are likely to bleed through to core inflation, which is already elevated.

5 and 10-Year U.S. Breakeven Inflation Rates

Source: Bloomberg

ISM Manufacturing Prices Index

Source: Bloomberg

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