Global bonds sold off as investors responded to central bankers signaling they will increase interest rates as much as necessary to bring down inflation.
The US two-year yield jumped to the highest level since November 2007 after Federal Reserve Chair Jerome Powell said at Jackson Hole a restrictive stance was likely to remain in place “for some time,” and “the historical record cautions strongly against prematurely loosening policy.” European bonds led the slide after a top European Central Bank official said more tightening is needed even if Europe’s economy tips into recession.
“Even though there was an expectation that Powell would be hawkish, he easily exceeded those expectations,” said Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. “I was surprised US rates markets did not move more on Friday night. We retain our view for flatter curves following all the Jackson-Hole communication over the weekend.”
Global bond markets are balancing inflation risks against the threat of an economic slowdown that may be exacerbated by aggressive central bank rate hikes. Some investors had been positioning for a pivot away from tightening, though that narrative met opposition from Powell and others at Jackson Hole.
Dollar Bull
The Fed’s leadership of a global hawkish policy wave and strength of the US economy is also sending the dollar surging. The Bloomberg Dollar Spot Index jumped as much as 0.6% to approach a record high set in July. The currency’s gains came as swaps traders boosted their expectation for where the Fed rate will be a year from now to 3.82%, from 3.68% a week ago.
“I can’t see anything other than the dollar going higher,” said Stephen Miller, an investment consultant at GSFM, a unit of Canada’s CI Financial Corp. “US rates are going to go higher than in Europe and the UK because they both face economic dysfunction that complicates the capacity of central banks there to be as aggressive as the Fed.”
The yield on the US two-year note climbed as much as eight basis points to 3.48%, while that on the 10-year security increased by a similar amount to 3.13%. The inversion of the yield curve, currently at 36 basis points, is not as extreme as the levels reached earlier this month.
The advance in short-end yields has some investors looking to buy in at these levels. The sell-off is attractive in a relative sense given the “bang for the buck” even with the amount of volatility, said Dave Plecha, Global Head of Fixed Income at Dimensional Fund Advisors. “We’re sort of buying into weakness in a sense.”
Powell and most other top officials from the world’s biggest central banks delivered a clear message at Jackson Hole that they are ready to keep imposing higher rates until inflation substantially moderates, even if that does economic damage. That said, early hiker New Zealand may be nearing the end of its aggressive tightening cycle, according to its central bank governor.
The global debt sell-off was led by European bonds, where some European Central Bank officials are floating an unprecedented 75-basis-point hike. Executive Board member Isabel Schnabel warned the likelihood of inflation expectations becoming unanchored is uncomfortably high. German two-year yields rose as much as 21 basis points to 1.20% on Monday.
“The rhetoric of the ECB Governing Council members speaking at the Jackson Hole Symposium was unambiguously hawkish,” said UniCredit analysts including Marco Valli. “This is likely to put further pressure on short-dated European government bonds.”
Jackson Hole left traders divided on whether next month’s policy meeting will see the Fed match the past two gatherings with a three-quarter point hike or slow down to a half point move. Still-elevated inflation makes a rate increase inevitable, but the size “will depend on the totality of the incoming data and the evolving outlook,” Powell said.
Friday’s US payroll report -- along with the next consumer-price-index numbers on Sept. 13 -- are among the biggest of the data points that will matter for the Fed and global bonds.
“The Fed’s fight with inflation is far from over and a dovish pivot remains in the distance,” said David Chao, a global market strategist at Invesco. “The US labor market remains tight, which will probably support wage growth and overall spending and purchasing power despite high inflation.”
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