Is U.S. inflation really not as optimistic as it seems?

The market may be underestimating the long-term inflation risks in the United States. A recent research report from Deutsche Bank points out that although key inflation expectation indicators appear stable on the surface, in-depth analysis reveals that the market's real concerns about future inflation are close to the highest levels in a decade, closely related to tariff threats and worries about the independence of the Federal Reserve.

An article from Wall Street Insight shows that the core CPI in the U.S. was below expectations for five consecutive months in June, and the market's inflation expectation indicators also seem relatively mild. Deutsche Bank's analysis indicates that recently, key indicators measuring long-term market inflation expectations—5-year, 5-year forward breakeven inflation rates (5y5y breakevens) and inflation swaps—although they have risen to near twelve-month highs, are still within a controlled range overall.

However, Deutsche Bank's Chief U.S. Economist Matthew Luzzetti and his team warned in a report released on July 17 that this apparent calm is deceptive. The bank's analysis found that once the strong impact of oil price fluctuations is stripped away from these indicators, a "risk premium" indicator that better reflects real inflation concerns emerges, and it has climbed to near the highest level since 2014.

Inflation Expectations "Distorted" by Oil Prices: Potential Risk Premium Rises to a Decade High

Key indicators measuring long-term market inflation expectations are largely influenced by oil price trends. The report points out that since the mid-2014 oil price crash, there has been a correlation of up to 75-80% between spot oil prices and long-term inflation expectation indicators such as the 5-year/5-year forward breakeven inflation rate and inflation swaps.

To more accurately assess market sentiment, Deutsche Bank stripped away the impact of oil prices. The results show that the "residual" inflation expectations after excluding oil price effects have "significantly risen" in recent weeks and months. The report emphasizes that this value is close to the highest point since 2014, with the only period exceeding the current level being the "Trump reflation trade" from late 2016 to early 2017.

Deutsche Bank thus concludes that the market's view of inflation risks may not be as "optimistic" as the direct data suggests. Against the backdrop of ongoing tariff threats and uncertain Federal Reserve policy prospects, if relevant policies are truly implemented, this inflation risk premium may further rise.

Policy Uncertainty Drives Up Risk Premium

Deutsche Bank points out that the current potential tension in inflation expectations mainly stems from uncertainty at the policy level On one hand, there is the erratic tariff policy of the Trump administration, and on the other hand, Trump continues to challenge the independence of the Federal Reserve, repeatedly signaling his intention to fire Powell.

The bank believes that this contrast between apparent calm and deep-seated concerns reflects the market's complex assessment of the inflationary risks in the coming years. If the current U.S. administration truly follows through on its threats regarding tariffs and Federal Reserve policies, the current risk premium may continue to widen.

Deutsche Bank's report aligns with former Treasury Secretary Summers' warning that the Trump administration's policies could trigger inflation.

An article from Wall Street Journal states that former U.S. Treasury Secretary Summers warned that President Trump’s attempts to control the Federal Reserve and push for interest rate cuts could lead to a surge in inflation expectations, thereby raising long-term borrowing costs:

I don't know of any mainstream economist who supports a 1% interest rate in the current environment. Such a move might bring economic prosperity in the short term, but at the cost of creating severe inflationary psychology