"Given the downside support from the Fed and the relatively low level of breakevens, we think investors should continue to maintain long positions in 30-year TIPS and in breakevens," Morgan Stanley told clients.
The U.S. five-year, forward rate used to measure inflation expectations rose as high as 1.75% late last week compared with post-crisis lows of 1.42% in February.
The big question is whether the picture in the United States—and to a lesser extent Britain—is exceptional or whether it is a bellwether of global inflation trends.
In Europe and Japan, inflation remains near zero, and any significant rise appears a distant prospect, as cheap oil, the slowdown in China and other emerging economies, and the U.S. dollar's rise of over 20% in just four years weigh.
More than $6 trillion of European and Japanese sovereign bonds currently trade at negative yields, suggesting investors remain skeptical that years of extraordinary monetary stimuli from central banks will reignite consumer price inflation.
German 10-year nominal bond yields shrank below 0.10% for the first time in a year this week, and economists talk of negative central bank deposit rates persisting for years.
Eurozone five-year inflation swaps are falling back toward February's record low of 1.36%, while even the University of Michigan's five-year U.S. inflation outlook index is hovering around its lowest ever, comfortably below 3%.
‘More Positive Backdrop’
Jamie Searle, rates strategist at Citi in London, says there may be signs that European demand for inflation protection is slowly beginning to pick up, particularly from investors looking to hedge longer-term inflation risk.
"There's a growing sense that the bounce in U.S. TIPS has helped create a more positive backdrop. It's quite tentative though—we're not talking about a broad-based pickup in global inflation here," he said.
So much now hinges on the oil price.
After rallying more than 50% from lows earlier this year, world crude is struggling to get a foothold above $40/barrel. The persistent supply glut and ebbing global demand suggests $30/barrel could be revisited as easily as $50, especially if no meaningful deal to limit production is struck.
But some think the rollback in U.S. shale oil output that is already underway—itself a response to the oil price collapse—may be enough to create a price floor.
"While there are near-term downside risks to prices as the market continues to rebalance, the medium-term forwards ... may actually under-price how we expect fundamentals in the energy market to evolve," Goldman Sachs strategists Francesco Garzarelli and Rohan Khanna wrote in a research note on Tuesday.