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Markets Preparing For Inflation?

Written by A Forex View From Afar on Wednesday, May 20, 2009

The financial market is going through some major changes, which are likely to influence the outcome of the economic activity over the coming periods.

Currently, most market participants expect the pace of contraction seen in the global economy to slow, while a small group of investors even anticipate a number of positive signs of growth in the upcoming quarter. With this being said, the financial markets expect demand to pick up again, led by emerging countries like China and Brazil whereas the developed world is to lag behind.

Another important change that the financial markets are experiencing these days is the fact that inflationary expectations are coming back to life, and very fast. The inflation breakeven level, or the spread between the 5-year TIPS and the similar maturity Treasury note, experienced a sudden shift in sentiment since March, when the equity rally first started.

TheLFB-Forex.com Trade Team notes that in March, the breakeven rate was standing at -0.20%, meaning that investors expected a rather prolonged period of disinflation and/or deflation. However, things have suddenly changed with the equity rally. Right now, the same breakeven spread sits at 0.60%, a sharp change in just a little more than two months.

The market’s inflation expectation is fueled by the strong expansionary policies ran by the Fed and the other central banks, and by the gains seen in the commodity markets. TheLFB-Forex.com Trade Team commented that oil rose nearly 80% from the low reached earlier this year, something that will soon be reflected in the monthly CPI numbers. Moreover, the quantitative easing policies, to expand the monetary base by intervening in the bond market, will also add to inflationary pressures.

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