Uncertainty in bond markets will remain high.
Another week starts with the market focusing on a possible escalation of tensions in Ukraine. The situation is unclear, with reports showing that Russia is ready to invade Ukraine any moment on one side and Emmanuel Macron brokering a summit between Vladimir Putin and Joe Biden on the other. What is certain is that volatility is likely to maintain elevated until Russian troops pull back from the Ukrainian border. Until then, we can expect the equity market to remain vulnerable and US Treasuries and Gold to serve as safe-haven. Yet, geopolitical tensions are not alone in moving the US Treasury market. Expectations of a more aggressive Federal Reserve continue to adjust, causing the front part of the yield curve to advance or pare back interest rate hikes. While at the beginning of last week, markets were pricing a 50bps rate hike next month, by Friday, expectations dropped to 25bps. Fed official speeches contribute to uncertainty in the rates market, as they do not give explicit direction regarding the central bank's intentions. As money market guru Zoltan Pozsar highlighted in recent research, uncertainty could benefit the Federal Reserve's purpose to tighten the economy more efficiently to fight inflationary pressures.
He explains that a way to do so is to spark a market crash, which causes much labor tightness.
Even if the Fed does not want to cause a selloff voluntarily, it might be nearly impossible for it to avoid a tantrum. On the one hand, if it does not do enough to curb inflation, it could spark an inflation tantrum. On the other, if it is too aggressive, a taper tantrum might ensue.
This week, investors will need to focus on the Personal Consumption Expenditure Index released on Friday, which is expected to come out at 6%. An overshoot might revive more aggressive interest rate hikes expectations. Before Friday, the focus will be on the 2-year, 5-year. 7-year US Treasury auction starting tomorrow and on Federal Reserve speakers.