Markets are abuzz with renewed inflation concerns as the US-Iran conflict drives energy prices skyward. But here's the twist: amidst the chaos, a subtle yet significant shift is unfolding in the bond market.
You might think that with traders scrambling for safety, Treasury yields would follow suit and drop. But surprisingly, the opposite has occurred! Since last week's close, Treasury yields have risen, with 10-year yields climbing 5 basis points to 4.107%. This marks a notable 15 basis points increase from February's closing levels.
As traders grapple with the dual challenge of securing safe assets and factoring in higher inflation expectations, the latter seems to be gaining the upper hand. This becomes even more evident when we consider the surge in oil prices, with WTI crude oil soaring over 6% to $75.65, a high not seen since June of last year.
Now, here's where it gets intriguing. The market's response is starting to align with central bank pricing. The clamor for rate cuts is fading, and a new narrative is emerging—one that favors rate hikes.
A closer look at Fed fund futures reveals a telling story. The probability of a July rate cut has plummeted to a mere 65%, and by year-end, traders are now anticipating only around 43 basis points of rate cuts by the Fed. This is a stark contrast to the 59 basis points anticipated just last week.
The petrodollar's resurgence is not the only factor at play here. The winds of change are blowing, and they're keeping the dollar in high demand this week.
In a surprising turn of events, traders are now assigning a 25% chance to the ECB raising interest rates by year-end. And this likelihood has only grown stronger, reaching nearly 40%, following the hotter-than-expected inflation figures in the euro area.
Just last week, traders were certain the ECB would remain stagnant throughout the year. Policymakers were even downplaying the possibility of a rate cut. But now, the tables have turned, and we find ourselves contemplating the prospect of rate hikes from the ECB.
The BOE, much like the Fed, has witnessed a substantial decrease in the likelihood of rate cuts. Traders initially expected around 52 basis points of rate cuts by year-end, but that expectation has now shrunk to a mere 24 basis points.
When we connect the dots, it becomes clear that inflation is reclaiming its place at the forefront. This shift is prompting a significant change in the outlook for major central banks, potentially overshadowing any temporary risk reactions to the US-Iran conflict.
