Decoupling

Investors are starting to realize that President Trump may be causing some dents in the independence of the Federal Reserve when it comes to control inflation and set the monetary policy independently, as per its mandate. The chart below shows the 2 year Overnight Index Swap, that basically measures the expected overnight rate set by the Fed (an alternative to Fed fund futures) versus 5 year inflation swap, which tells us how the market sees 5 year inflation in 5 years time. As you can see the correlation has been very high between both lines, and perhaps this episode is similar to the one in December 2023, where the light blue line (inflation) came down, but subsequently the dark blue line trended up as the Fed hiked. If the Fed maintains its independence, we could see rate hikes. If on the contrary, the White House takes over, one way or another, we may see rates lower, (dark blue line down) and inflation higher (light blue line up), which is not good if the idea is to have a central bank that really cares about price stability.

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