Five-Year/Five Year Forwards: US and Europe

The five-year/five year forward has been cited by various officials in the US and Europe as a useful metric of inflation expectations. It is interesting to review where they are in light of the ECB's likely hike this week and increased talk about inflation in the US as commodity prices, especially oil prices, continue to edge higher.

The US 5-year/5-year forward, which is a five year forward on the second five years of a 10-year TIP implies expected inflation of 2.57%. It has largely moved in a 2.30%-2.70% range for most of Q1 after being confined mostly to a 2.70%-3.00% range in Q4 10. By this measure inflation expectations have eased, not risen.

In Europe, we use the French 5-year/5-year forward as a proxy for the euro zone. It is make new highs today and is currently near 3.22%. It had been in a 2.80%-3.20% range. In the last two months of 2010, the French 5-year/5-year forward was in a 2.40%-2.80% range.

The UK 5-year/5-year forward is at 3.97% today. It has been trending higher in recent weeks, but is well within the range seen in Q1 of mostly 3.80%-4.20%, with some brief breaks lower.

As is well appreciated, the US continues to pursue QEII. Whereas the labor market is gradually improving, with Q1 11 the best for job growth in almost 7 years, core inflation and inflation expectations remain what central banker call "anchored". The BOE is not engaged in quantitative easing, but given the number of letters it has written to the Chancellor, it seems they have effective suspended their inflation target. The ECB is not engaged in what it would call quantitative easing, but it has purchased covered bonds and sovereign bonds and more importantly, continues to provided unlimited amount of liquidity at fixed rates and will continue to do so after they hike rates late this week.