Battle of Brexit Versus Biden Looms Large in Inflation Markets

(Bloomberg) -- Inflation markets in the U.K. and the U.S. may diverge in the coming weeks, with immediate political outcomes in either country being key drivers.

Forward inflation swaps in the pound and the dollar fell on Thursday, in line with the broad declines in bond yields, as the question of where price pressures are headed occupied the spotlight. Traders are pondering what a trade deal -- or lack thereof -- with the European Union may mean for inflation in the U.K., while similar questions abound over what a Joe Biden presidency would mean for stimulus and price trajectory in the U.S.

While other factors, such as a recovery in either economy, will wield more influence on inflation’s trajectory longer term, politics will gain sharper focus near term.

Despite today’s pullback, pound-denominated five-year, five-year inflation swaps have recovered from the lows of March to trade around 3.60%, above a five-year average. Should the U.K. and the EU reach a deal by Dec. 31, it could send the pound higher and lead to crumbling inflation expectations. On the other hand, a no-deal Brexit is bound to roil the currency, which would increase the cost of imported goods and lift inflation estimates.

Over in the U.S., an equivalent measure has risen to trade near the highest in a year. It coincides with rising yields on longer-dated bonds and a rally in the S&P 500 Index this month that has left valuations around a record, all predicated on the expectation that a Biden victory would lead to an opening of the fiscal purse strings.

That would stoke inflation expectations, especially against a backdrop where the Federal Reserve has adopted a policy framework where it will tolerate above-average prints for longer.

The next few weeks could be key as the Nov. 3 U.S. presidential election looms. For the U.K., Prime Minister Boris Johnson will probably decide whether to carry on or walk away from talks after an EU summit on Thursday and Friday, according to a person close to the discussions. Others familiar with the matter said both sides now consider the end of October or first few days of November as the real deadline.

NOTE: Ven Ram is a currency and rates strategist for Bloomberg’s Markets Live. The observations are his own and not intended as investment advice.

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