Super Central Bank Week Approaches, Inflation Concerns Surge, Market Storms Unavoidable?

Author: Yang Dapan, Jintou Data

This week, some of the world’s most important central banks may give investors new reasons to sell government bonds, as policymakers find themselves forced to confront inflation risks triggered by war.

The Federal Reserve, European Central Bank, as well as the central banks of Japan, the UK, and Canada will all hold interest rate decisions this week. This creates an extremely rare week: all G7 central banks gather together to jointly decide on monetary policy that influences half of the global economy.

Although investors expect them to hold steady, the market will be highly alert to signals, watching whether officials including Fed Chair Powell and ECB President Lagarde, are concerned about inflation threats from unprecedented oil supply disruptions caused by the US-Iran conflict.

Signs of such concerns and speculation that policies will remain tight or tighten further in the coming months could negatively impact government bonds. In recent weeks, as traders selectively ignored the war’s impact, pushing stocks and credit markets higher, government bond performance has lagged behind other assets.

With the Bank of Japan meeting on Tuesday, the Bank of Canada on Wednesday, and the Federal Reserve, ECB, and Bank of England on Thursday, Amy Xie Patrick is among those investors preparing for a busy week. She manages a dynamic income strategy at Pendal Group, which has beaten 91% of its peers over the past five years.

“What’s the loss in releasing some hawkish comments now by central bankers?” Xie Patrick said, noting she has already fully hedged her duration exposure this month. “There’s an oil shock now, and inflation outlook remains uncertain. Bonds were supposed to follow the reversal we saw in stocks, but yields are stuck until the situation becomes clearer.”

Government bond yields remain high

Despite some major assets being repriced to pre-war levels or higher, short-term government bond yields from the US to the UK remain elevated.

Traders trying to profit from bond volatility are also disappointed. So far this month, the daily average change in yields for 1-3 year government bonds has been about two basis points, below March’s four basis points.

Stephen Miller, former head of fixed income at BlackRock Australia, said, this situation could change.

Central bank officials are wary of new inflation pressures, fearing a repeat of the mistaken judgment during the pandemic that “inflation is temporary,” when many were caught off guard by its stubbornness. That lesson is likely to keep policymakers cautious, even as concerns about economic growth intensify.

Miller, now an advisor at GSFM, pointed out: “Central banks’ language could just as easily burst the bond market’s bubble, pushing yields higher. Bond traders might be surprised by how strongly the Fed focuses on inflation.”

For example, in the UK, officials say the war will worsen inflation. Driven by a sharp rise in fuel prices, the country’s March Consumer Price Index (CPI) rose 3.3% year-over-year, up from 3% last month.

As a result, last week’s trading shifted expectations for this year’s rate hikes from just one increase to at least two.

In the US, Fed officials have warned that the conflict could further fuel inflation or even force them to reconsider rate hikes; at the same time, they emphasize that how long oil prices stay high remains uncertain.

Amid ongoing headlines about the US and Iran, the overall macro backdrop makes it difficult for bond investors to price in strong expectations of rate cuts later this year until the oil shock situation clarifies. However, employment and retail sales data remain resilient, indicating the economy is still robust.

Short-term US Treasury yields, most sensitive to monetary policy changes, fell last Friday after the US Department of Justice dropped its investigation into the Fed, potentially paving the way for President Trump’s favored candidate Kevin Warsh to succeed as Fed Chair and push for rate cuts.

US Treasury yields have been oscillating within a narrow range. Over the past week, market expectations for a rate cut by the end of the year have fluctuated between 25% and 60%.

Molly Brooks, a US interest rate strategist at TD Securities, expects, “Powell will adopt a ‘neutral stance’ because the impact of Middle East tensions on the future remains uncertain.” She believes the Fed will acknowledge in its statement that “recent inflation has risen due to oil shocks,” while also noting that “underlying inflation is only slightly elevated.”

Brooks said TD Securities expects that, “given the uncertainty ahead and the lack of forward guidance from the Fed, the 10-year Treasury yield will continue to trade within the 4.1% to 4.4% range.”

In other regions, Bank of Japan Governor Ueda Kazuo has emphasized the need for a comprehensive assessment of potential inflation risks. Evercore ISI strategists predict that the Bank of Japan will attempt to present a “hawkish hold” stance, paving the way for rate hikes in June and December.

ECB President Lagarde, in a recent speech, also highlighted rising uncertainties, and is likely to reiterate this message at Thursday’s meeting. According to swap pricing, a rate hike in June is almost certain, with another possible increase by September.

While anxiety over short-term inflation persists, if rising prices and geopolitical pressures begin to erode demand, markets and major central banks may ultimately shift focus to economic growth concerns. This shift could lower official and market borrowing costs. Wee Khoon Chong, senior market strategist at BNY Mellon Asia-Pacific, said:

“Markets will closely watch for hawkish signals to maintain current expectations for rate hikes in the Eurozone, UK, Canada, and Japan. Geopolitical uncertainties and high oil and petrochemical prices pose both inflationary and growth risks. Central banks are likely to convey a cautious hawkish tone but avoid making any firm commitments on future rate moves.”