Stay informed with free updates
Simply sign up to the Bonds myFT Digest — delivered directly to your inbox.
For months it has felt like the world has been connected in an “everything trade” — with prices swung higher or lower by the President’s 39 pronouncements that a deal was super-imminent. Now a deal looks like it has finally been signed, reopening the Strait of Hormuz and chucking a ton of money at the hardline Iranian regime.
MainFT’s Malcolm Moore writes that “fears of summer shortages and $200 oil have been replaced by a focus on looming gluts”, with oil prices down around a third from peak. At the start of the conflagration we looked at how inflation expectations tracked oil prices, cratering global bond markets. So what’s happened since, and why aren’t bond yields lower?
A few charts:
As the price of crude oil ripped higher, so did the price of one-year and two-year US inflation swaps. People get tetchy about whether these really equate inflation expectations, but inflation expectations is what they say on the tin.
The price of two-year inflation swaps incorporates all the inflation that might come over the first year, so you can infer from the gap between the two blue lines that folks reckon prices would jump mechanically with higher energy costs, but not necessarily that this was the birth of a new inflation cycle.
And bonds are moved by inflation expectations, right?
Up to the middle of May the yield on two-year Treasuries moved pretty much in lockstep with the market price for hedging inflation. What changed? Expectations around what the Fed would do.
Short-dated bond yields track inflation expectations mainly because the market reckons that inflation expectations matter to the price of overnight interest rate set by the Fed.
And charting out the fed funds rate implied in futures prices for December 2026, it’s easy to see where the market’s assessment of what is driving fed funds changes drifted from the market’s price to hedge inflation.
You could say that inflation expectations have fallen precisely because the market — and by extension the world — has understood that a new Warsh-led Fed is no pushover. And last night’s post-Fed market reaction that saw dollars jump in value against stocks, bonds, gold, crypto and most currencies might support this view.
But scanning back through economic releases it looks mostly like a mix of hawkish April minutes, chunkier than expected personal consumption expenditure deflator and CPI prints, strong consumer spending numbers and a bumper payrolls report. All of which culminated in the everything trade beginning to unwind some weeks ago.
Unfortunately for Trump, whose penchant for low rates is well known — along with debtors everywhere — this unwind has stranded bond yields higher and left the Fed leaning into a new tightening cycle.
Good luck explaining this to your new boss Kevin.
