The Russian invasion of Ukraine is a game-changer for central banks' monetary policies worldwide; that's what the bond market says. Inflation pressure will soar and remain sticker, and central banks will not be able to be as hawkish as initially expected due to a considerable slowdown in growth.
Short-term breakeven rates rose to their highest on record, with the 2-year German breakeven rate rising to 3.5%, the 2-year US breakeven approaching 4% and the 5-year UK breakeven rate hitting 4.8%.
The breakeven rate is the difference between nominal bond yields and the yield of an inflation-protected bond. It tells the market's inflation expectations at a specific time in the future. Interestingly, a fast drop in real yields has led to today's sudden rise in breakeven rates. The bond market tells us that central banks will not be able to fight inflation with an aggressive rate hiking cycle without hindering risk assets' discount margins and growth. The risk of stagflation has risen sharply.
Although nominal yields have dropped across the whole yield curve on the safe-haven demand, their fall has been contained as markets believe that sticky inflation will force central banks to implement tightening policies regardless of growth.
Therefore, the bias for flatter yield curves remains intact, significantly if the situation worsens. As Steen Jakobsen, Chief Investment Officer at Saxo Bank, highlighted in a recent piece: “Western powers will have to hurt themselves if they are to hurt Russia as new sanctions are likely to affect the flow of commodities itself and possibly Russia’s financial system and its access to the world”. Basically, there is a high probability that inflationary pressures might worsen.