(The author is editor-in-chief for finance and markets at Reuters News. All opinions expressed here are his own)
LONDON (Reuters) – Financial markets appear to have a case of double doubts – not sure the US Federal Reserve will maintain its composure by postponing interest rate hikes until 2024, but now questioning their own aggressive assumptions about ‘a tightening at the end of next year.
Investors entered April in a more optimistic mood after one of the worst quarters for long-term bonds in 40 years.
US yields slide back as second quarter kicks off despite explosive US jobs report in March, highest growth rate ever in service sector, trillions of dollars in additional government spending and inflation angst continues. And it’s not entirely clear why.
The answer over the next few months will be crucial not just for the bond market itself, but for everything from tech stock valuations to heavily leveraged emerging economies or the strength of the dollar around the world.
One of the reasons given for the apparent overhaul of yields was that money market expectations for a full Fed rate hike of a quarter point by December 2022 were likely overcooked and the bond market was more than fully assessed for rate hikes or their consequences.
Looking at Eurodollar deposit futures, they look extreme and estimate almost 100 basis points of Fed tightening ahead of when the median of Fed policymakers’ forecast indicates the central bank will even start to raise. rates in 2024.
Even if the truth lies somewhere in between, it leaves considerable room for market adjustment on the policy.
And already, with little to no change in this picture of futures, 10-year Treasuries yields – which nearly doubled in the first quarter – are down about 15 basis points from the late high. March at 1.77%. And retirement has been right through the 2 year to 30 year curve.
In the face of such sparkling economic and fiscal policy headlines, this decision is either an end-of-quarter quirk or a reassessment of inflation risk.
For traders, like Mike Owens of Saxo Markets, the repositioning around the end of the quarter last week and the surprise rise in US payrolls in March is the most likely culprit behind the “misleading” drop in prices. returns this week.
“Sentiment remains bearish over the long term,” says Owens.
Some analysts, such as those at Rabobank, point to the Fed’s decision last month not to extend its suspension of the banks’ additional leverage ratio rule beyond the March 31 deadline, the main cause of the sale of Treasury bonds by primary traders in the middle of the month. .
If this triggered the sharp rise in yields in March, then the fundamental picture investors see may not have changed as much as it has surfaced.
For all the reasonable angst about what happens to prices in an economy allowed to “heat up” from here, there is no shortage of economists who doubt the story of soaring inflation.
The five-year inflation expectations built into the inflation-protected bonds now sit below 2.70% since the middle of last month, with 10-year and 30-year rates stabilizing for weeks at good levels. lower around 2.30% and 2.20%.
While these readings are nearly the highest in a decade, they will hardly alarm a Fed that has struggled to bring inflation back to its 2% target for much of those 10 years.
Indeed, it now actively targets this type of rate for a period in order to have any hope of reaching its new average inflation target of 2% over time.
But the latest global forecast from the International Monetary Fund sees little sign of a persistent global inflation spurt.
Although the IMF has raised its inflation forecast for 2022 by 0.2 percentage point compared to January for all advanced economies, this call remains only 1.7%. The quarterly forecast for the end of this year still never exceeds 2%.
The IMF has insisted that this year’s rise in inflation – largely due to the base effects of 12-month oil and commodity price rebounds as well as market bottlenecks. supply linked to the pandemic and pent-up demand for services – is unlikely to last.
Prices in sectors less sensitive to cyclical fluctuations present few or no underlying problems, he added. And so-called “reduced-average” inflation rates that eliminate extreme price fluctuations indicate a fall rather than an increase in inflationary pressure.
“Moderate” wage growth and weak workers’ bargaining power have been compounded by high unemployment, underemployment and lower participation rates, he said in his World Economic Outlook.
And even if the overall economic margin is lower than estimated, the flatter “Phillips curve” relationship between jobs and wages over many years means there is less risk of lock-in.
“For the same reason that inflation did not drop much when output gaps were large and negative during the global financial crisis, inflation is unlikely to rise much (now),” he said. declared.
For investors, plowing a middle furrow is the only option.
JP Morgan Asset Management market strategist Karen Ward says this ‘massive experiment’ in economic policy will surprise on the upside, with inflation more likely to average 3% over the next 10 years than 1% and yields on 10-year US Treasuries still likely to head. closer to 2% this year.
Others may be happy to just take the yield and run.
Pictet Asset Management chief strategist Luca Paolini says the fear of inflation could hit corporate credit, but says Treasury valuations are “increasingly attractive”.
by Mike Dolan, Twitter: @reutersMikeD; Edited by Alexander Smith