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US inflation: Less downside risk than is priced – Goldman Sachs

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Dec 30, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    FXStreet (Delhi) – Research Team at Deutsche Bank, suggests that economic slack is running out and the extent to which this is true varies widely across the G7 economies, but they’re all running out, and the average G7 unemployment rate is now less than 100bp above its 30-year lows.

    Key Quotes

    “The depletion of slack is most advanced in the US, where headline unemployment currently stands at 5.0% and is expected to fall to 4.6% by the end of 2016. These are levels of unemployment not seen in the US since the summer of 2007, and we expect this will go a long way towards convincing bond markets that deflation risk is much lower than is priced. It is also likely that upside inflation risk will reprice, too, although as we point out below, our conviction is lower here than for the mispricing of deflation risk.”

    “Expectations of low inflation will also be challenged by base effects in oil prices, which will add to inflation in 2016 just as they subtracted from it in 2015. The price of WTI oil, for example, has recently fallen below $42/bbl, and while our Commodities team thinks the near-term risks to prices remain skewed to the downside, they continue to believe that the supply and demand adjustments being forced by cheap oil will support the market at $52/bbl by the end of 2016. Thus, in sharp contrast to the loose intuition that ‘low commodity prices are deflationary’, commodity price inflation could easily exceed 20% next year.”

    “As US unemployment rates reach our forecast of 4.6%, we expect to see an unwind of the deflation premium that is still priced into rates and inflation markets. And while Europe will take longer to reach full employment than the US, we do not think this justifies the 65% probability of 5-year inflation in the Euro area remaining below 1%. As these option-implied probabilities show, markets are pricing far more downside risk to inflation that we think likely.”
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