Markets are betting that rates will rise earlier than expected

The investors bets are increasing that the world’s major central banks will raise their interest rates ahead of schedule, and faster than they’d like.

According to a Bloomberg index, global bonds are heading for their worst year since 2005, with traders forecasting rate hikes to come in all developed economies.

This is because they believe that central bankers, who have recommended patience since the arrival of the COVID-19, have begun to change course. Policy makers now seem more concerned that pandemic inflation will continue, and more willing to increase borrowing costs to eradicate it.

Nowhere has the turnaround been sharper than at the Bank of England, where three words from Governor Andrew Bailey last weekend – “we will have to act” – were enough to push the latest phase of the bid to tighten up. Just a few weeks ago, Bailey said that the “hard blows” for the economy were yet to come.

Markets now forecast a hike by the Bank of England for next month, and they see the abandonment of cheap money is accelerating in other countries as well.

A more restrictive Fed?

Investors anticipate that the Federal Reserve will raise interest rates by half a percentage point by the end of 2022, and they expect some developed economy countries to have made several hikes by then.

This is not the outlook central bankers have generally projected over the past 18 months. Instead, they have argued that pandemic inflation will decline soon, and that interest rates should be kept low to help pick up growth and hiring, an argument also made by some investors.

“If the Fed were to go up too fast,” then “they might suddenly realize that global demand waned and then domestic growth would slow accordingly,” said Peter Chatwell, director of multi-asset strategy at Mizuho International Plc. “We would say that a Fed hike in the fourth quarter of 2022 would be premature.”

But the rhetoric of monetary policymakers has changed as more and more key indicators – from oil markets and shipping conditions to consumer and employment surveys – suggest that pressures on prices.

With inflation above target almost everywhere, that’s a prospect that even today’s dovish central banks indicate they are not going to ignore.

‘More aggressive’

“The next few months are critical to assess whether the high inflation figures that we have seen are transitory,” Fed Governor Christopher Waller said Tuesday. “If monthly inflation figures remain high for the remainder of this year, a more aggressive policy response could be justified for 2022 than simply reducing asset purchases.”

Current bets for the Fed’s first hike are focused on July or September next year, and some think it could come even earlier. Last month, officials were evenly divided on whether they should act next year or wait until 2023. In March, a hike was not expected until 2024.

Treasuries are being dragged down by the selloff, down 3.3% this year through Oct. 21, according to a Bloomberg index. This is not far from the record annual decline of 3.6% in 2009. The 10-year Treasury yield has risen more than half a percentage point since the beginning of August, to almost 1.7%. A bond market gauge of 5-year inflation expectations topped 3% on Friday for the first time in history. ”The Fed appears to be bracing for the possibility of some kind of rate hike, or of keeping that option open. , during the second half of next year, ”says Subadra Rajappa, head of the rate strategy in the United States at Société Générale. That “could be enough to calm some of the fears in the market that the Fed has no control over inflation.”

Europe too?

Even in the eurozone, where there hasn’t been an interest rate hike in more than a decade, there could be one next year, investors are now speculating. They only foresee a small adjustment, which would keep the reference rate of the European Central Bank deposit facility well below zero. The Governor of the Bank of France, Francois Villeroy de Galhau, warned markets not to expect even that. “There is no reason for the ECB to raise its interest rates next year,” he said Tuesday, because inflation is likely to It will be back below the 2% target by the end of 2022 – a few months or so and a few basis points – this is how many central bankers in advanced economies continue to view things.

They assume that inflation will decline as the supply side of economies returns to normal, and even then it should be allowed to stay above forecasts for economies and labor markets to recover. They may also expect that, by speaking harshly, inflation expectations will recede without the need for hikes.

‘It worries me’

Many investors say that this approach underestimates the risks. “I’m concerned – and more and more people in the markets seem to do so – that there might be a surprise on the sustained side of inflation,” says Jack Malvey, a bond market veteran and former chief global fixed income strategist at Lehman. Brothers Holdings Inc, which is now a director of the Center for Financial Stability.

Also, with rates at or near zero throughout the developed world, investors don’t have much choice to bet in the opposite direction, making betting on rate hikes hard to resist.

Still, most investors aren’t pushing central banks too hard, at least not yet.