Investors expect higher interest rates as inflationary pressures mount

Featured Sponsor

Store	Link	Sample Product
UK Artful Impressions	Premiere Etsy Store

Stronger-than-expected US inflation and increased consumer spending fueled global expectations that interest rates will rise as expectations about future monetary policy change rapidly.

The Federal Reserve’s preferred measure of inflation Data released on Friday showed it topped expectations in April, as consumer spending in the US rose last month and new orders for long-life goods rose unexpectedly.

Kristalina Georgieva, head of the IMF, warned on Friday that US interest rates would have to stay higher for longer to tame inflation that had been more persistent than expected. She added that a loss of confidence in US Treasury markets would spell turmoil for the global economy.

Short-term government debt yields in the US, UK and eurozone have started to rise again as investors switch from betting on an economic slowdown to anticipating more protracted rate hikes to match price increases.

The shift in rate expectations marks a big shift for fund managers and traders, who have spent much of the year trying to predict when central banks would start cutting interest rates.

Futures markets are now pricing in a 37% chance of another interest rate hike by the Powered in June, having previously anticipated that the next move would be a cut.

The yield on two-year Treasuries, which are particularly sensitive to investors’ interest rate expectations, rose to 4.6%, from a low of 3.7% earlier this month. Yields rise when prices fall.

Adding to indications that the US economy is still moving forward, inflation-adjusted personal consumption rose 0.5% in April from a flat reading in March as spending on services such as insurance and health care has increased.

“We continue to be surprised by the rising inflation data and that’s a problem,” said Florian Ielpo, macro head at Lombard Odier Investment Managers.

Durable goods orders, which include washing machines, cars and airplanes, rose 1.1% from the previous month, beating economists’ expectations for a 1% decline.

developments in the United States debt ceiling negotiations they also pushed US yields higher as White House negotiators try to strike a deal with the Republican leadership in the House of Representatives this weekend.

European and UK yields also increased. The UK’s two-year debt yield jumped as much as 0.6 percentage points this week to over 4.5%, its highest level since October. The equivalent yield on German bonds has fallen from around 2.5% earlier this month to just under 3%.

Investors were particularly disturbed by high underlying inflation – a measure that eliminates volatility in food and energy prices – which puts pressure on central banks to hike rates further, even at the risk of a recession.

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

In a recent note, BlackRock analysts said most developed economies “are grappling with a shared problem. . . core inflation is proving more stubborn than expected and remains well above central banks’ 2 per cent targets.

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

Earlier this month, markets had priced in a further rate hike by the European Central Bank to 3.5%, but futures markets now expect the rate to peak at 3.7% by October.

“Europe is actually just behind where the US is in the business cycle, so we think the ECB is further ahead [rate increases] go,” said Mark Dowding, chief investment officer at BlueBay Asset Management.

In the UK, data released this week showed core inflation rose 6.8% in the year to April, faster than economists expected.

Imogen Bachra, head of UK rate strategy at NatWest, called the figures a “game changer” for interest rates. Swap markets are pricing in a Bank of England cap rate of up to 5.5% by November, up from 4.9% a week ago, much higher than the current 4.5%.