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Will inflation get out of control over the next 5 years?
The chart below comes from the Cleveland Fed, which uses derivatives based on US CPI inflation to derive the market-implied distribution for expected inflation over the next 5 years.
It’s a fascinating chart.
I plotted the market-implied distribution for expected 5-year inflation in a pre-pandemic period (2018) and today (2025). What can we notice?
- The median expected inflation is roughly the same: 2.14% vs 2.22%. BUT...
- The distributions are drastically different: the 90th percentile of the 2018 distribution was 3.26%, while today it sits at 4.87%!
- This is also visible from the shape of the distributions: the 2025 distribution has more excess kurtosis and a much bigger skew.
What does it mean?
-> Today, investors are pricing much higher odds of inflation exceeding 3% over the next 5 years than before!
This is not an estimate or a guess: this is what investors are paying to protect themselves against much higher and stickier inflation down the road - this distribution is taken from actual CPI-based derivatives traded in markets.
Do you think investors are justified in hedging such risks?
What are the odds that inflation will get out of control over the next 5 years?
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