Concerns about inflation: The turnaround in interest rates is intensifying on the bond market

The bond market sell-off continued at the start of the week.

The price losses pushed up yields on both sides of the Atlantic.

The trend-setting market interest rate for ten-year Bunds rose to 0.63 percent on Monday, the highest level since mid-2018. Four interest rate increases by the European Central Bank (ECB), each by 0.25 percentage points, are now being priced into the money market over the next twelve months.

That would mean that the deposit rate would rise from minus 0.5 percent to plus 0.5 percent.

While falling commodity prices, particularly the drop in oil prices, created confidence on the stock market, concerns about inflation and the associated expectation of a significant tightening of monetary policy weighed on the interest rate markets.

Markus Fruehauf

Editor in Business.

• Follow I follow

The yield curve of American government bonds is causing a stir.

This has been inverted for a few weeks between the five- and ten-year terms.

That means the five-year yield is higher than the ten-year yield.

On Monday, the five-year US yield of 2.66 percent even exceeded the 30-year figure of 2.64 percent for the first time since 2006.

The return on the ten-year Treasury was 2.47 percent.

An inverted yield curve reflects the market's expectations of a recession.

In view of the high inflation rates in the United States and the emerging second-round effects in the form of wage increases, market participants are preparing for an even tighter monetary policy from the US Federal Reserve (Fed).

Fed fuels interest rate expectations

Fed President Jerome Powell had already triggered a sell-off in bond markets last week by hinting at rate hikes that could be higher than market expectations.

A week ago, market participants on the American money market were still assuming that the key interest rate would be 1.75 percent higher at the end of the year.

An increase of 2.15 percentage points is now expected.

According to Commerzbank interest rate strategist Rainer Guntermann, the Fed is fueling expectations of rate hikes of 0.5 percentage points.

This ensures rising yields, especially in shorter maturities, while investors are more relaxed about the dangers of inflation at the long end.

Guntermann assumes that the bond markets will remain under pressure.

This also applies to Bunds, whose yields are being driven by fears of tightening.

All eyes are on this week's upcoming inflation rates for March.

According to estimates by Commerzbank economists, the rise in energy prices triggered by the war in Ukraine should cause consumer prices in Germany to rise by 7.5 percent after 5.1 percent in February.

The German inflation rate will be published on Wednesday.

Two days later, on Friday, comes the inflation for the euro area.

Here, the Commerzbank economists expect an all-time high of 7.7 percent.

In view of such strong currency depreciation, the representatives of the ECB are likely to continue to signal their willingness to raise interest rates.

ECB more cautious than Fed

DZ Bank analyst Birgit Henseler expects the ECB deposit rate to rise by 0.25 percentage points in December and another interest rate hike in early 2023. Over a one-year horizon, yields on ten-year Bunds would rise to 1 percent.

Henseler assumes that the ECB will proceed much more cautiously than the US central bank.

"Nevertheless, the pressure on the monetary authorities to declare war on the high price pressure is also increasing in this country," she wrote in her interest rate forecast, which she published on Monday under the title "Trend reversal on the bond market".

"The phase of moderate growth rates without inflationary risks with an expansive monetary policy is probably coming to an end," says Henseler.

According to the analysts of the major American bank JP Morgan, it will take some time to tell whether the rising interest rates will also herald a trend reversal on the stock market.

Recessions don't typically begin with yield curve inversions, wrote the team led by senior equity strategist Mislav Matejka.

The delay could last up to two years.

So far, stocks have always performed significantly better than bonds during this period.

Historically, the stock market has peaked about a year after the yield curve inverted.

In addition, the yield curve is not yet inverted in the classic sense.

Then the two-year yield would have to be higher than the ten-year one.

For the strategists at JP Morgan, the clock has not yet started ticking.

But the analysts at Morgan Stanley do not share the confidence in shares.

Chief strategist Michael Wilson believes that the stronger headwind from tighter monetary policy, high inflation and the Ukraine war has not yet been priced in.