Despite recent inflation nearing double digits, market expectations for inflation five years out remained stable at the Fed's 2% target. Austan Goolsbee argues this was only possible due to the Fed's credibility, which prevented a dangerous spiral where people's actions make high inflation a self-fulfilling prophecy.

While energy shocks drive European front-end inflation, the key driver has changed. The sensitivity of inflation swaps to oil prices has faded significantly, while sensitivity to natural gas prices has picked up, making TTF gas a more critical indicator than Brent crude for European inflation expectations.

ECB President Lagarde's statement that disinflation is over is likely a backward-looking comment on the progress from 10% inflation. However, the ECB’s own forward-looking forecasts project inflation will fall below its 2% target, suggesting that future rate cuts are more likely than the confident public rhetoric implies.

Morgan Stanley holds a contrarian view that the European Central Bank will cut rates in June and September. This is based on the expectation that an upcoming inflation print will fall below the ECB's target, fundamentally shifting the policy debate. A below-target reading would reverse the burden of proof, forcing policymakers to justify not easing policy further.

Policymakers can maintain market stability as long as inflation volatility remains low, even if the absolute level is above target. A spike in CPI volatility is the true signal that breaks the system, forces a policy response, and makes long-term macro views suddenly relevant.

While Brent crude prices retraced 85% of their recent spike, Euro area front-end inflation measures have only fallen 25%. This muted reaction, smaller than in the US or UK, indicates the market is pricing in persistent indirect effects from past energy costs, creating an asymmetric upside risk for Euro inflation.

The Federal Reserve can tolerate inflation running above its 2% target as long as long-term inflation expectations remain anchored. This is the critical variable that gives them policy flexibility. The market's belief in the Fed's long-term credibility is what matters most.

Unlike the US Fed, the European Central Bank is expected to raise interest rates in response to the energy shock. This is because its single mandate focuses purely on inflation, and Europe historically experiences stronger 'second-round effects' where energy prices lead to broader wage increases.

Even as recent inflation surged, market expectations for inflation five years out remained stable at the Fed's 2% target. This demonstrates the power of the Fed's credibility. If the market loses faith, it can trigger a self-fulfilling wage-price spiral, making it much more painful for the central bank to rein in inflation.