Bonds tumbled across the world on Thursday after Federal Reserve Chairman Jerome Powell’s latest hawkish pivot, with yields from Wellington to London breaching multi-year highs.
Expectations are growing that the Fed’s stance will spur more rapid tightening from central banks across the world. U.K. two-year yields surged to a decade-high, while New Zealand’s 10-year rate touched the highest in three years. German notes proved more resilient than Treasuries, sending the gap between U.S. two-year yields and equivalent German schatz to the widest since February 2020.
The global bond selloff sets the stage for major central bank meetings next week, the highlights being the European Central Bank, Bank of England and Reserve Bank of Australia. Traders brought forward tightening bets for each of them as Powell’s comments created a global spillover effect.
“As the Fed readies itself to lift rates, probably in March, so the world holds its breath to see if tighter Fed policy produces adverse spillover effects in overseas markets,” said Standard Bank strategist Steven Barrow. “With the market priced for the Fed to push the fed funds rate up to no more than 1.75% by the end of 2024, it seems to us that pricing is far short of where the Fed needs to go.”
Global bonds endured their worst rout since 2005 last year, and the start of this one hasn’t been any easier. Markets are repricing rates higher on expectations central bankers will need to embark on tightening cycles to reign in surging inflation.
Wednesday’s Treasury rout was led by shorter-dated notes, shrinking the gap between yields on these securities and those on longer maturities. Such bear-flattening moves often stoke investor concern that a central bank will end up hiking rates so fast that it hurts rather than controls economic activity. U.S. two-year yields rose four basis points to 1.19% at 6:13 a.m. in New York, after jumping by the most since March 2020 on Wednesday.
“We look to be in for a potentially faster and larger hike cycle than was previously thought,” said Damien McColough, head of fixed-income research at Westpac Banking Corp. in Sydney. “Powell made no mention of ‘gradual’ or any other disclaimer. Yields will push higher today and over coming days, with the curve bear flattening.”
Global Ripples
Gilts led the bond selloff in Europe with 10-year yields rising as much as seven basis points to 1.27%. Similar to the U.S., front-end rates led the charge higher, with two-year yields closing in on 1% for the first time since 2011. Traders are betting the BOE will hike rates to 1% in June from 0.25% currently, starting off with a quarter-of-a-percentage point rise next week.
The resilience in European debt was evident across the core and periphery, with Italian bonds outperforming. Meanwhile, the dollar extended its gains, sending the euro to the weakest since June 2020. Traders are setting their sights on next week’s ECB meeting, where policy makers are likely to guide market expectations for rate hikes.
Recent comments from the central bank “suggest that the ECB will be slow to adjust policy on the belief that inflation will prove transitory,” said Saxo Bank’s John Hardy. “Eventually, as central bank expectations rise, a capitulation from the ECB on the need to guide for rate hikes could prove a watershed moment that supports the euro, but this moment has not yet arrived.”
Japan, China
Japan’s benchmark yields closed at the highest since 2018, while their Chinese counterparts extended a gain from the 20-month low touched earlier this week.
New Zealand 10-year yields rose as much as nine basis points to 2.70%, buoyed also by national data showing a 31-year-high for inflation. Australia’s 10-year yield rose as much as 12 basis points to 2.06% while three-year yields surged beyond 1.50% for the first time in almost three years.
Australian consumer prices surprised once more to the upside earlier this week ahead of a pivotal RBA policy meeting on Feb. 1. The nation’s bond market melted down in late October after a CPI reading came in hot enough to spur speculation the RBA would have to scrap yield-curve control. The central bank pulled the plug on that part of its pandemic-era stimulus package and now economists and investors expect the RBA will scrap quantitative easing next Tuesday.
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