Global bond markets have been extra reactive lately.
Some of this makes sense. The Federal Reserve is expected to cut interest rates this year, but the speed and timing of those cuts will depend on the outlook for inflation.
The extent of markets’ sensitivity to economic data is what’s really notable: Two-year global bond yields have reacted more to economic surprises than any time since the 2008-2009 global financial crisis, according to Goldman Sachs data :
Again, the central idea is pretty reasonable. There’s a ton of economic uncertainty — mostly over the outlook for inflation — so global bond yields are very responsive to things like CPI data and data that could be linked to stickier service-sector inflation, like PMIs:
Here’s how GS describes it:
The rise in bond market sensitivity to growth data surprises reflects several unusual post-Covid activity dynamics. In 2020 and 2021, markets focused on the timing of large swings in activity associated with shutdown and reopening of the economy. Then, from 2022 to 2023, fears of a recession due to central bank rate hikes and disagreement over the prospects of a soft landing kept markets highly sensitive to any indication of a downward inflection in activity. Now, as recession fears have faded, market participants remain focused on whether activity has cooled enough for inflation to sustainably return to central bank targets.
It’s also notable that global bond yields are responding, not just domestic US bonds. The bank’s economists attribute most of this to the broader fact that global bonds are very sensitive to US yields — the Fed really is the world’s central banker, after all:
GS argues that this effect should recede in the next “12-24 months”, as central banks start cutting, and as inflation itself gets less volatile (we can only hope):
First and foremost, much of current market sensitivity should fade as rate cut campaigns get under way. Although it is increasingly likely that major central banks will initiate rate cut cycles in June, most major central banks have not started to normalize policy rates yet, so rate cut plans remain fairly exposed to near-term surprises . . .
Second, uncertainty around inflation should decline as price pressures trend closer to target. Inflation is notoriously difficult to forecast, with absolute errors (relative to consensus) on one- and two-year ahead consensus inflation forecasts regularly exceeding 0.4pp. Given that inflation remains the main driver of policy and that uncertainty around inflation forecasts is high, it is unsurprising that markets remain sensitive to inflation surprises.
But they add that as long as rates stay above at zero, there will probably be more rates volatility than there was between the end of the global financial crisis and Covid.