Brace for a high June inflation reading — but the surge so far hasn’t led to ‘unanchored’ expectations, says BlackRock

While BlackRock is expecting the CPI print to remain “pretty lofty” over the short term, market-based measures of inflation expectations over the long term have fallen recently, Chaudhuri noted.

Fears of “unanchored” inflation expectations would manifest in the bond market, and so far they have not, she said, pointing to signals in the 10-year break-even inflation rate, the 5-year, 5-year forward inflation expectation rate and the inflation swap market.

For example, the 10-year break-even inflation rate, which measures where market participants expect inflation to be in the next 10 years on average, has fallen from its April peak this year. The 10-year break-even rate had dropped to 2.32% on July 11 from about 3% on April 21, according to data tracked by the Federal Reserve Bank of St. Louis. 

The 5-year, 5-year forward inflation expectation rate has also dropped since April. That rate, which measures expected inflation on average over the five-year stretch beginning five years from now, fell to 2.08% on July 11 from as high as 2.67% on April 21, according to data on the St. Louis Fed’s website. 

Read: When will inflation peak? U.S. consumers see light at the end of the tunnel, New York Fed survey suggests

“Despite all of the fears that we’ve had about inflation, bond yields still have been pretty rangebound,” said Chaudhuri. “They haven’t broken out to new highs for the year,” she said, pointing to the yield on the 10-year Treasury note.

The 10-year yield
TMUBMUSD10Y,
2.976%
has fallen in recent weeks as investors worry about slowing growth and the potential for a recession in the U.S. The yield declined to 2.958% Tuesday, down from as high as 3.482% in mid-June based on 3 p.m. Eastern Time levels, according to Dow Jones Market Data.

Even as the labor market remains strong, recession fears in the bond market are reflected in the inversion of the yield curve, with the yield on the 2-year Treasury note trading above the 10-year rate in recent days. The 2-year yield
TMUBMUSD02Y,
3.045%
fell Tuesday to 3.043%, about 8.5 basis points above the yield on the 10-year Treasury note, according to Dow Jones Market Data.

Meanwhile, small-business owners have never been more pessimistic about the future of the economy, with their biggest problem being inflation, according to a survey released Tuesday by the National Federation of Independent Business.

BlackRock’s Chaudhuri said that she expects the consumer-price index to show core inflation, which strips out food and energy, rose 0.5% in June. Such a monthly rise would still point to “a very strong trajectory of core inflation,” she said, adding that composition will be an important part of the CPI print on Wednesday.

 She’ll be paying close attention to the shelter component of inflation as it’s “a big driver” of core CPI, while looking for “any cooling in any of the goods-related areas of the market” such as household furnishings and used cars.

Chaudhuri said she’ll also be watching for how well “recreation” is holding up amid concerns over a slowing economy, as well as the cost of airline fares to help gauge consumer spending trends.

She told MarketWatch that she anticipates the Federal Reserve will hike its benchmark interest rate by three-quarters of a percentage point later this month in an effort to tame the surging cost of living.

Read: Fed’s Barkin wants to avoid repeat of stop-and-go monetary policy of 1970s

In this new regime of higher inflation, Chaudhuri recommends investors consider allocating to the iShares 0-5 Year TIPS Bond ETF
STIP,
-0.27%
for exposure to the “front-end” of the inflation-linked bond market.

Meanwhile, the U.S. stock market closed lower Tuesday as investors awaited Wednesday’s inflation reading for June. The Dow Jones Industrial Average
DJIA,
-0.62%
fell 0.6%, while the S&P 500
SPX,
-0.92%
and the Nasdaq Composite
COMP,
-0.95%
each dropped around 0.9%, according to Dow Jones Market Data.