Global bonds fell as traders brace for central bank tightening

Global government bonds suffered another wave of selling on Friday as traders raised expectations that the world’s major central banks will be forced to take more aggressive action to bring inflation under control.

Short-term debt, which is particularly sensitive to monetary policy expectations, was the focus of the sell-off. Due to lower prices, the yield on two-year US Treasuries – an important global benchmark – jumped 0.11 percentage points to 1.3%. This significant shift, for a market that typically moves in small increments, took returns to the highest level since the start of 2020.

Across the Atlantic, the five-year German Bund yield rose 0.13 percentage points and eventually closed above zero percent for the first time since 2018.

“Pricing of G10 policy rates has shifted strongly towards anticipation of earlier and faster hikes,” said William Marshall, interest rate strategist at Goldman Sachs.

The moves came at the end of a turbulent week for global monetary policymakers. The Bank of England raised its main interest rate for the second consecutive time on Thursday, while on the same day the European Central Bank announced a hawkish turn. A day later, a much stronger-than-expected US labor market report bolstered expectations that the Federal Reserve will aggressively raise borrowing costs this year to curb persistently high price growth.

Bill Papadakis, macro strategist at Lombard Odier, added that “the only key driver in the markets is this hawkish pivot now coordinated by major central banks.”

The speed with which policymakers have had to adjust their plans has been particularly brutal in Europe, where a report on Wednesday showed inflation in the euro zone unexpectedly hit a record high of 5.1%.

ECB President Christine Lagarde acknowledged on Thursday that inflation risks were “tilted to the upside” and declined to rule out rate hikes this year. Only last month she called such a move “highly unlikely”.

The hot inflation data and Lagarde’s more hawkish turn caused a significant adjustment in market expectations for the bank’s monetary policy outlook this year. Markets are now pricing rate hikes by half a percentage point by the end of 2022, up from around 0.12 percentage points at the end of last week, according to Bloomberg market trading data. money markets.

Giovanni Zanni, chief eurozone economist at NatWest, said Lagarde appeared to be “turning into a hawk” as she took more seriously the risks that inflation would continue to significantly exceed the medium-term target of 2 % of the ECB.

“Inflation has been more rigid than initially expected and risks are now on the upside,” said Fabio Bassi, rates strategist at JPMorgan.

Goldman expects the ECB to end its massive asset purchase program in June, followed by a quarter-point hike in the deposit rate in September and December, leaving the main policy rate of the central bank to zero by the end of this year.

Line chart of five-year Bund yield (%) showing a rise in short-term German bond yields due to ECB tightening expectations

A report on Friday showing the U.S. economy added 467,000 jobs last month — far more than the 150,000 expected by Wall Street analysts — bolstered expectations that the Fed will quickly scale back stimulus this year.

Following the jobs report, traders in the futures market began pricing in more US rate hikes. More than five quarter-percentage-point hikes are now expected this year, compared with between four and five before the release, according to Bloomberg data. That puts the Fed’s policy rate forecast at 1.3 percentage points by the end of this year.

Andrew Hunter, senior US economist at Capital Economics, said the Fed was “cleared to take off” on strong jobs numbers.

“The 467,000 gain in nonfarm payrolls in January is even stronger than it looks, as it occurred despite the spike in absenteeism caused by the wave of the Omicron virus and was accompanied significant upward revisions to earnings over the previous two months.”

Additional reporting by Naomi Rovnick

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