Bonds Bleed as Rate Hike expectations Soar
As the pace of vaccinations remains slow in the EU but continues to rise in the US and the UK, traders are pricing in the end of the pandemic this year, and that most of the world’s economies will reopen to full capacity. That is pushing inflation expectations higher and higher, along with other things.
Recently, traders paid attention to Friday’s payrolls report, and it was spectacular. In addition to a massive 916,000 jobs added in March amid broad-based job creation, the unemployment rate fell to 6% from 6.2%, while the underemployment rate declined to 10.7% from 11.1% – from 7% pre-pandemic.
“we will return to the pre-pandemic level of jobs by year-end,” said Bank of America (BoA) chief economist, “[the risk] is that the rate of job growth actually accelerates further given the stimulus-induced boost to spending and economic reopening.”
That, of course, means more inflation is coming, and with higher inflation, the Federal Reserve (Fed) will be expected to tighten monetary policy sooner rather than later.
At the moment, markets imply more than one rate hike by the end of 2022. Additionally, almost 140bps of tightening – almost 6 rate hikes – is now priced in between the end of 2022 to the end of 2024.
As yields soar, along with rate hike expectations, bonds have been suffering. The world’s largest credit ETF scored its worst month of outflows since it began trading about two decades ago.
Investors took nearly 3.6 billion USD from the iShares iBoxx Investment Grade Corporate Bond ETF (LQD) in March, according to data compiled by Bloomberg. That massive outflow came as the 42 billion USD fund suffered its biggest quarterly rout in 12 years.
What’s next? For us, it is hard to imagine precious metals and non-profitable tech stocks advancing in such an environment. The pressure on the Fed will continue to mount as inflation is clearly running loose across the globe.
Large-cap companies should perform better than small caps as they are more resilient to rising rates due to more solid balance sheets.
When it comes to the USD, it should be supported in this environment, and therefore we don’t expect the EURUSD pair to rise further above this year’s highs of 1.23.