The US bond market is dashing hopes of how quickly and quickly the Federal Reserve will raise interest rates as Russia’s war in Ukraine threatens to put pressure on global economic growth. Money-market traders have reduced any risk that the US central bank will begin its tight campaign this month with a half-point increase in what was once seen as a near certainty. Even a quarter-point increase is not entirely sure. At the same time, they have also marked where the Fed’s benchmark rate will peak, about 1.7%, a drop of 20 basis points from earlier expectations and well below the central bank’s long-term estimate of 2.5% for the rate.
The reassessment shows how much geopolitical uncertainty has changed the balance of risks facing the world’s monetary-policy makers, who now need to weigh the prospects of slowing growth, even as rising Energy and commodity prices threaten to fuel what is already the worst inflation rate in four decades. The move is being mirrored in US markets in the UK and Europe, where traders have also bet back rate-hike. “This is a significant increase in the steady winds blowing through the global economy,” Mohamed El-Erian, chief economic advisor at Allianz SE, said on Bloomberg TV. The market hasn’t recognized that, which is why the Fed will be less stringent. This is not because the inflation outlook is better. Its outlook is worse. This is because the growth outlook for the global economy is quite poor. ,
Treasury yields have declined in the wake of the Ukraine war, partly due to congestion in the most liquid investment havens. But rates of inflation-adjusted Treasury yields, called real yields, have also fallen as growth prospects eroded and bond-market gauges of short-term inflation expectations hit an all-time high.
The bullish reversal has led some investors to question whether the pullback in yields is over and whether the uncertainty cast by the war will actually divert the path of central banks seeking to moderate inflation. Some price moves may also have been exaggerated by a rush to cover bets against treasuries that had increased during the price hikes after the Russian invasion.
James Athe, investment director at Aberdeen Asset Management in London, is betting against those who think war could stifle the Fed’s tough plans. He expects any delayed rate hikes this year to be transferred to 2023 and said the decline in yields is more about some traders getting caught with short positions. “It’s a position squeeze,” Athe said. “Central banks were being forced to tighten by high inflation and high inflation expectations, not by high, rising growth or rising real wages,” he said. “So the fact that this position of Russia is probably bad for growth and bad for risk sentiment does not provide any excuse for central banks to dramatically change course.”
The market is now pricing in less than five quarter-point rate hikes from the Fed this year, compared to more than six such hikes two weeks ago. Traders are thus betting that the Fed could raise borrowing costs by less than 50 basis points next year before beginning cuts in 2024.
Rising inflationary pressures and growth risks have driven the fall in US real rates. The rate on five-year Treasury inflation-protected securities (known as TIPS) is now around negative 1.7%, down from negative 1% a few weeks ago.
The two-year break-even inflation rate, which measures the difference between TIPS and Plain Vanilla Treasury, last week became the highest since Bloomberg began compiling the data in 2004. It is hovering just below about 4.23%, which is somewhat above 3.2%. At the end of December. The five-year breakeven is 3.23% from 2.89% at the end of January.
Two-year Treasury yields, which more than doubled to 1.64% since the end of last year and mid-February, have retreated more than 30 basis points since then.
Part of the revised calculus for traders includes the possibility that if the Fed starts less aggressively this year it could be forced to catch up in 2023—all the while avoiding driving the policy rate so high that growth. Wait.
Priya Mishra, global head of rates strategy at TD Securities, said, “The Fed may be less aggressive to begin with, then it has to go further, with the market also saying the Fed will reduce.” To Russia’s concerns about global debt risk and risk as well as growth concerns. And even before Russia, the bond market was concerned about the strength of the economy over the next year and beyond. ,
With the assistance of Edward Bolingbroke
Liz McCormick and Yeh Zee are, respectively, senior reporter and global market reporter, Bloomberg
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