inflation

The yield on US 10-year Treasury bonds topped 2.8 percent on Tuesday, the highest point since 2018. The 10-year yield thus technically breaks the downward trend line that dominated the government bond market for the last four decades. “This is a harbinger of misery.”

While the Federal Reserve is expected to raise rates aggressively in the coming months, the European Central Bank, fearing the impact on Europe’s weaker economies, will remain reluctant to quickly boost Eurozone interest rates to mitigate the effects of rising prices. The ECB is due to provide a new monetary policy update on Thursday at its next six-week press conference.

When it comes to the prospect of a recession, and a possible prolonged period of stagflation, the jury is still out, even in Europe. Although in agreement on a deteriorating economic outlook, major asset managers such as BLI, Pictet and JP Morgan hold diverging views on what’s next. For investors, corporate earnings are now seen as the next waypoint.

The biggest risk for investors at the moment is high inflation. While the market places too much emphasis on short-term inflation, it also tends to underestimate long-term inflation.

The news that Powell might raise interest rates by 50 basis points next time was greeted with cheers, as it would bring inflation under control more quickly. However, the Fed will be able to live with inflation hovering between 3 and 4 per cent for a long time, although Powell will never admit that. In the eurozone, it is certainly not about fighting higher inflation.

The European Central Bank on Thursday opened the doors to a potential eurozone rate hike in the second half of this year as it brought forward the end of its asset purchasing programme to the summer, but at the same time it made clear that it would keep open its option to renew the programme if economic conditions worsen because of the war in Ukraine and sanctions against Russia.

Russia’s invasion makes it more difficult for central banks to keep inflationary pressures at bay. Rising commodity prices weigh on the cost of living in the US and Europe. Restrictive effects of the Ukraine war on economic recovery are also increasing, but a full-fledged stagflation scenario so far appears premature, one investment strategist told InvestmentOfficer.

Global financial markets were in turmoil on Thursday in a clear sign that investors had not expected Russian President Vladimir Putin to make an aggressive move into Ukraine by launching a full-scale invasion.

“Even just yesterday people were dismissing this as unlikely,” well-known economist and Fed watcher Mohamed El-Erian, advisor at the Allianz & Gramercy said. “This is way beyond anything. This is a very unsatisfactory situation.” 

Investors awaiting higher yields on government bonds have systematically been missing out for four decades. While market rates are rising, bondholders remain on the edge of their seat. With central banks set to tighten monetary policy, the question is: who is going to buy government bonds?

A leading German economist on Monday urged investors not to exaggerate financial risks around a possible Russian invasion of Ukraine, saying an invasion would merely lead to a “temporary setback” while underlining the need to put the Russia risk into perspective.

“All in all, we would expect the European economy and markets to rebound shortly afterwards from a temporary setback which a Russian attack on the Ukraine would probably cause,” said Holger Schmieding, Chief economist at German private bank Berenberg. “Let’s hope it does not come to that.”

President Biden and Olaf Scholz, the new German Chancellor, are not on the same page regarding Nordstream 2. Biden threatens that no natural gas will flow through the pipeline if Russia invades Ukraine. But for Germany, Moscow is much closer and Scholz will realise that 40 percent of all natural gas in Europe comes from Russia.

Unlike the Netherlands, Germany is actually switching to natural gas, away from lignite and oil boilers. Meanwhile in Moscow, Macron is trying to de-escalate the issue, if only for the upcoming French elections.