Central Bank Policy Expectations Continue to Pressure Global Yields. Is the End in Sight?

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Thursday, June 30, 2022

Central bankers from the European Central Bank (ECB), Bank of England (BOE) and the Federal Reserve (Fed) met this week in Sintra, Portugal at the ECB’s annual conference to discuss strategies to arrest stubbornly high consumer prices. The combined impact of the COVID-19 pandemic, supply-chain challenges, Russia’s invasion of Ukraine, and a delayed response from central banks has resulted in high inflation, low growth, and increasing recession risks as central banks scramble to tighten financial conditions and slow demand. The inflation shocks across developed markets have delivered an aggressive repricing of monetary policy expectations with virtually all developed market central banks (with the exception of the Bank of Japan) embarking on, or shortly starting, a frontloaded tightening cycle. Policy interest rates were increased a record 80 times in the first six months of 2022. And based on Bloomberg Economics’ forecasts, the GDP-weighted global policy rate is set to rise to 4.6% at end-2022, up from 3% a year earlier.

As such, and as seen in the LPL Chart of the Day, the sudden repricing of higher policy rates has pushed longer-maturity government bond yields higher this year with many countries seeing its interest rates increase by over 1.5%, the largest increase in decades.

View enlarged chart.

Moreover, for Eurozone countries, net buying under an asset-purchase program is also set to end on Friday, which has been a large driver of higher yields over the past few months in the more indebted countries like Greece, Italy and Portugal. However, ECB officials are working on a separate bond buying tool to help prevent “fragmentation” which should help minimize the prospects of another Eurozone debt crisis similar to the one experienced in 2009.

Central bankers in Sintra this week have also stated their concern about inflation expectations becoming unanchored, adding to the urgency to continue to aggressively raise interest rates. Moreover, Jay Powell (Fed) and Christine Lagarde (ECB) both shared their concerns that we may be on the verge of a new higher inflationary regime, which may mean longer-lasting inflation shocks and still higher policy rates. “While some of the aggressive rhetoric may just be jawboning as a way to keep inflation expectations anchored,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “It’s clear that global central bankers learned from the 70s and 80s and are taking the threat of inflationary challenges seriously and are at least willing to consider pushing economies into a recession to help stave off runaway consumer prices.”

So what do markets think about the prospects of a new higher global inflation regime? Right now, market-implied inflation expectations remain elevated in the near-term but fall decisively over intermediate and longer-term time periods. Central bankers will be watching these markets closely to see how aggressive they actually have to be. Unless, or until, market-implied inflation expectations become unanchored, central bankers may not have to be as aggressive as markets are currently expecting.


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