What's the bond market saying
The story this week is bonds. We've seen some of the wildest moves since the pandemic and what makes them so tricky is that they've come out of the blue to some extent, with no real trigger setting off most of them. And the ones with triggers have been shockingly large.
1) US long end yields tumbling back to 1.55% after a test of 1.70% along with 20s-30s inversion
2) UK yields blowing up, including talk of some mid-sized firms blowing up
3) The RBA abandoning yield curve control in a Soros moment
4) Canadian front end jumping on the BOC surprise
5) German-Italian spreads popping
I could go on because the price action has touched just above every global sovereign market this week.
In the big picture, we still have long-term yields well below inflation and well below target despite the front end pricing in more and more hikes. For example, a June FOMC hikes is 92% priced in and the taper won't even be done by then, assuming the $15/b month pace in the Minutes plays out.
So what gives?
There are two schools of thought and one is that the Fed is going to be too aggressive and the other is that they'll be too late.
ZeroHedge makes the case for the Fed being too late then being forced to hike too aggressively, citing former PIMCO CIO Mohammed El-Erian.
"A delayed and partial response initially, followed by big catch-up tightening-would constitute the biggest monetary policy mistake in more than 40 years," El-Erian argued, adding that it would "unnecessarily undermine America's economic and financial well-being" while also sending "avoidable waves of instability throughout the global economy."
The other idea is that the Fed is going to overreact to transitory inflation. That they will hike too much in 2022 and 2023 only to find out that it was transitory all along. Prices will fall and inflation will settle back into the post-GFC range of 1-2%. Rather than letting inflation run out and re-anchoring inflation expectations, they'll snuff out inflation and cement the Japanification of rates.
I'm more inclined towards the second idea, if only because we've seen a handful of episodes where good economic data or high inflation data is met with a decline in yields at the long end. The shift at central banks this week and last is being treated the same way.
