Investors expect higher interest rates as inflationary pressure rises

Stronger-than-expected US inflation and a jump in consumer spending have fueled expectations around the world that predictions about future monetary policy will turn sharply.

Data published in April showed the Federal Reserve’s favorite measure of inflation expectations in April, while US consumer spending rose last month and new orders for long-durable goods rose unexpectedly.

IMF chief Kristalina Georgieva warned on Friday that US interest rates would need to stay high for a long time to moderate inflation which was more stable than anticipated. He added that a loss of confidence in the US Treasury markets would mean turmoil for the global economy.

Yields on short-term government debt in the US, UK and eurozone have begun to rise again as investors hope for more long-term rate hikes to counter the rise in prices, betting on an economic downturn.

The shift in rate expectations is a big turnoff for fund managers and traders, who have spent the year predicting when central banks will start cutting interest rates.

Futures markets are now pricing in a 37 percent chance of another interest rate hike by the Fed in June, with earlier speculation that the next move would be a cut.

The yield on two-year Treasury bonds – especially sensitive to investors’ interest rate expectations – has risen to 4.6 percent from a low of 3.7 percent earlier this month. Yields increase as prices fall.

In a sign that the US economy is still growing, personal consumption, adjusted for inflation, rose 0.5 percent in April, up from a flat reading in March, as spending on services such as insurance and healthcare increased.

“We are surprised to see inflation figures go up and that is an issue,” said Florian Ilpo, head of macro at Lombard Odier Investment Management.

Orders for durable goods, which include washing machines, cars and aircraft, rose 1.1 percent from the previous month – more than economists expected to decline by 1 percent.

Developments in US debt ceiling talks have also lifted US yields as White House negotiators look to strike a deal with the Republican leadership of the House of Representatives later this week.

European and UK yields have also increased. The yield on Britain’s two-year debt jumped 0.6 percentage points this week to more than 4.5 percent, its highest level since October. Equivalent German bond yields have risen from around 2.5 per cent earlier this month to less than 3 per cent.

Investors have been particularly vexed by high core inflation – a measure that separates volatile food and energy prices – which puts pressure on central banks to raise rates even at the risk of recession.

“We’re certainly not out of the danger zone yet,” said Sonja Laud, chief investment officer at Legal & General Investment Management.

In a recent note, analysts at BlackRock said most advanced economies “are grappling with a common problem. . . core inflation is proving more stubborn than expected and is well above central banks’ 2 percent target.”

“We think this means that central banks cannot undo any inflation-fighting increases any time soon,” they wrote.

Earlier this month, markets braced for another 3.5 percent rate hike by the European Central Bank, but now futures markets are expecting a 3.7 percent hike by October.

“Europe is effectively right behind where the US is in the economic cycle, so we think the ECB has to go further (to hike rates),” said Mark Dowding, chief investment officer at Bluebay Asset Management.

In the UK, data published this week showed core inflation rose 6.8 percent in the year to April, faster than economists had predicted.

Imogen Bakhra, head of UK rates strategy at NatWest, called the data a “game changer” for interest rates. Swap markets are pricing the Bank of England’s maximum rate until November at 5.5 percent, up from 4.9 percent a week ago, much higher than the current 4.5 percent.

Stronger-than-expected US inflation and a jump in consumer spending have fueled expectations around the world that predictions about future monetary policy will turn sharply.

Data published in April showed the Federal Reserve’s favorite measure of inflation expectations in April, while US consumer spending rose last month and new orders for long-durable goods rose unexpectedly.

IMF chief Kristalina Georgieva warned on Friday that US interest rates would need to stay high for a long time to moderate inflation which was more stable than anticipated. He added that a loss of confidence in the US Treasury markets would mean turmoil for the global economy.

Yields on short-term government debt in the US, UK and eurozone have begun to rise again as investors hope for more long-term rate hikes to counter the rise in prices, betting on an economic downturn.

The shift in rate expectations is a big turnoff for fund managers and traders, who have spent the year predicting when central banks will start cutting interest rates.

Futures markets are now pricing in a 37 percent chance of another interest rate hike by the Fed in June, with earlier speculation that the next move would be a cut.

The yield on two-year Treasury bonds – especially sensitive to investors’ interest rate expectations – has risen to 4.6 percent from a low of 3.7 percent earlier this month. Yields increase as prices fall.

In a sign that the US economy is still growing, personal consumption, adjusted for inflation, rose 0.5 percent in April, up from a flat reading in March, as spending on services such as insurance and healthcare increased.

“We are surprised to see inflation figures go up and that is an issue,” said Florian Ilpo, head of macro at Lombard Odier Investment Management.

Orders for durable goods, which include washing machines, cars and aircraft, rose 1.1 percent from the previous month – more than economists expected to decline by 1 percent.

Developments in US debt ceiling talks have also lifted US yields as White House negotiators look to strike a deal with the Republican leadership of the House of Representatives later this week.

European and UK yields have also increased. The yield on Britain’s two-year debt jumped 0.6 percentage points this week to more than 4.5 percent, its highest level since October. Equivalent German bond yields have risen from around 2.5 per cent earlier this month to less than 3 per cent.

Investors have been particularly vexed by high core inflation – a measure that separates volatile food and energy prices – which puts pressure on central banks to raise rates even at the risk of recession.

“We’re certainly not out of the danger zone yet,” said Sonja Laud, chief investment officer at Legal & General Investment Management.

In a recent note, analysts at BlackRock said most advanced economies “are grappling with a common problem. . . core inflation is proving more stubborn than expected and is well above central banks’ 2 percent target.”

“We think this means that central banks cannot undo any inflation-fighting increases any time soon,” they wrote.

Earlier this month, markets braced for another 3.5 percent rate hike by the European Central Bank, but now futures markets are expecting a 3.7 percent hike by October.

“Europe is effectively right behind where the US is in the economic cycle, so we think the ECB has to go further (to hike rates),” said Mark Dowding, chief investment officer at Bluebay Asset Management.

In the UK, data published this week showed core inflation rose 6.8 percent in the year to April, faster than economists had predicted.

Imogen Bakhra, head of UK rates strategy at NatWest, called the data a “game changer” for interest rates. Swap markets are pricing the Bank of England’s maximum rate until November at 5.5 percent, up from 4.9 percent a week ago, much higher than the current 4.5 percent.