Higher-than-expected inflation in the US and a sharp increase in consumer spending have fueled expectations around the world for higher interest rates as outlooks for future monetary policy change rapidly.
Preferred Federal Reserve Measure inflation Data released on Friday came in above April expectations as US consumer spending surged last month and new orders for durable goods unexpectedly surged.
Kristalina Georgieva, head of the IMF, warned on Friday that US interest rates must remain higher for longer to curb inflation, which has proved to be more resilient than expected. She added that a loss of confidence in the US Treasury markets would spell turmoil for the global economy.
Yields on short-term government debt in the US, the UK and the euro area have started to rise again as investors shift from betting on economic slowdowns to waiting for longer rate hikes to counter higher prices.
The shift in interest rate expectations marks a big change for fund managers and traders, who have spent much of the year trying to predict when central banks will cut interest rates.
Futures markets are currently estimating a 37 percent chance of another rate hike by the end of the year. fed in June, tentatively expecting the next step to be downsizing.
The 2-year Treasury yield, particularly sensitive to investor interest rate expectations, rose to 4.6% from a low of 3.7% earlier this month. Yields rise as prices fall.
In addition to signs that the US economy is still moving forward, inflation-adjusted personal consumption rose 0.5 percent in April from March as spending on services such as insurance and health care rose.
“We continue to be surprised by the inflated inflation data, and that’s a problem,” said Florian Yelpo, head of macroeconomics at Lombard Odier Investment Managers.
Orders for durable goods, including washing machines, cars and aircraft, rose 1.1% from the previous month, beating economists’ expectations of a 1% decline.
Events in the USA debt ceiling negotiations also pushed the US to higher yields as White House negotiators seek to strike a deal with the Republican leadership of the House of Representatives this weekend.
Yields in Europe and the UK also rose. The yield on two-year UK debt jumped 0.6 percentage points this week to more than 4.5%, its highest level since October. The equivalent yield on German bonds fell from about 2.5% earlier this month to just under 3%.
Investors were particularly concerned about high core inflation – a measure that cuts out volatility in food and energy prices – which is forcing central banks to raise rates even more, even at the risk of a recession.
“We are definitely not out of the danger zone yet,” said Sonia Laud, chief investment officer at Legal & General Investment Management.
In a recent note, BlackRock analysts stated that most developed countries are “struggling with a common problem. . . Core inflation has proved more resilient than expected and remains well above the central banks’ target of 2 percent.”
“We think this means that central banks will not be able to reverse any of their inflation-fighting rate hikes anytime soon,” they wrote.
Earlier this month, markets were looking for another 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 actually lags behind the US in the business cycle, so we think the ECB has further room. [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% year-on-year through April, faster than economists had forecast.
Imogen Bahra, head of UK rate strategy at NatWest, called the figures a “game changer” for interest rates. Swap markets are pricing the BoE’s peak rate to 5.5% by November from 4.9% a week ago, well above the current 4.5%.