The second half of 2017 just got a lot more interesting for investors scrambling to keep pace with a hawkish shift in the world’s biggest central banks.
Based on overnight index swap rates and with the Bank of England and the Bank of Canada now seen as more likely than not to join the Federal Reserve in raising rates before the year is out, two weeks of rhetoric from policy makers in Europe and North America has rewritten the outlook for markets. Even slowly growing is the possibility of a European Central Bank hike, once seen as all but impossible.
While with the dislocations in money markets also rippling through global bonds, after years of easing, traders are being shocked by the prospect of four of the world’s five largest central banks moving to tighten policy at the same time.
“Bond markets have been conditioned to thinking that whenever there was a slip-up in risk appetite somewhere and a tightening in financial conditions, the central banks would come to their rescue,” said Mark Chandler, Toronto-based head of fixed-income strategy at RBC Capital Markets. “Now it’s almost as if the central banks are engineering the tightening in financial conditions. Does that mean more volatility? The sure answer would be yes.”
As ECB President Mario Draghi said that reflationary forces had replaced deflationary ones in the region, the euro had its best day since April on Tuesday and the German 10-year yields climbed the most since 2015. And after Governor Mark Carney appeared to move closer to the hawks on his Monetary Policy Committee by saying it may need to begin removing stimulus, the pound surged and two-year gilt yields reached the highest since June 2016 on Thursday.
Across the Atlantic, as BOC Governor Stephen Poloz reiterated the central bank may be considering higher rates, the loonie surged the most in over a year and the yield on Canada’s two-year government bonds shot up above 1 percent for the first time since January 2015.
Chair Janet Yellen has reiterated that the central bank’s tightening is on track, keeping two-year Treasury yields close to an eight-year high, eBottom of Form
ven in the U.S., where inflation gauges have tumbled below the Federal Reserve’s 2 percent target. Policy makers had expected to raise rates three times at the beginning of the year. Traders are pricing in better than 50 percent odds that they’ll stick to their plan and raise borrowing costs again before year-end as the banks and policy makers have already hiked twice.
Traders are paring their outlook for the Fed and ratcheting up their expectations for other central banks while U.S. policy makers may continue to tighten. And the result is the further narrowing of rate differentials between higher-yielding Treasuries and other sovereign bonds.
“The trend in rates has been pretty much straight down throughout the first half of the year,” said Doug Porter, Toronto-based chief economist at Bank of Montreal. “That may reverse in the second” half
(Adapted from Bloomberg)