Key factors behind the volatility in fixed income markets

Executive summary:

  • Government bond yields rose in the UK and Canada amid stronger inflation data
  • The U.S. December retail sales report exceeded expectations  
  • So far, geopolitical events in the Middle East have only modestly impacted oil prices

On the latest edition of Market Week in Review, Senior Director and Chief Investment Strategist for North America, Paul Eitelman, and Product Operations Analyst McKenna Painter discussed key drivers behind the recent volatility in fixed income markets. They also chatted about the latest geopolitical developments in the Middle East and the potential impact on energy markets.

What’s driving the surge in government bond yields?

Painter and Eitelman opened the conversation by examining the recent rise in interest rates around the globe, with Eitelman noting that yields on government debt rose in the UK, Canada and the U.S. during the week of Jan. 15.

One factor likely responsible for the uptick was higher-than-anticipated inflation data from the UK and Canada, he said. “In both of these countries, the December numbers came in a little bit stickier and higher than consensus expectations—in stark contrast to the U.S., where price pressures have eased over the past few months,” Eitelman stated. For instance, in Canada, headline inflation rose to 3.4% in December on an annualized basis, while in the UK, consumer prices climbed 4% last month from one year earlier, he said.

In the U.S., the jump in interest rates can probably be attributed to a few factors, including December’s retail sales figures, Eitelman noted. “Retail sales increased 0.6% last month, showing that the U.S. economy is still pretty resilient right now,” he stated. In addition, U.S. unemployment claims for the week ending Jan. 13 fell to a 16-month low, signaling additional resilience, Eitelman said. “While there’s been a deceleration in hiring, the U.S. labor market hasn’t seen an increase in layoffs,” he remarked.

Last but not least, Eitelman said the rise in interest rates can also be partly pinned on recent remarks by U.S. Federal Reserve (Fed) officials, some of whom have pushed back a bit against the idea of aggressive rate cuts. “There’s been some speculation that the Fed could quickly pivot to lowering borrowing costs soon, with a potential initial rate cut in March. However, Federal Reserve Governor Christopher Waller indicated recently that he thinks the Fed shouldn’t rush into cutting rates, stating that the process should be undertaken in a careful manner,” Eitelman commented.

Could shipping disruptions in the Middle East cause a surge in inflation?

Shifting to recent headlines from the Middle East, Eitelman said that Western airstrikes against Houthi targets in Yemen—carried out in retaliation for Houthi attacks on shipping lanes in the Red Sea—have only had a modest impact on energy markets so far.

“Crude oil prices, which are a good barometer of geopolitical tensions in the Middle East, are up about 2% since the U.S.-led airstrikes began on Jan. 12,” he noted. Zooming out over a broader time horizon, however, current prices are still hovering near two-year lows, Eitelman stated.

He said that the disruption of some of the shipping traffic through the Red Sea has also sparked investor concern over a pickup in inflation. “Some investors are no doubt thinking back to the massive shipping disruptions that occurred at the tail end of COVID-19, which contributed to the steep uptick in global inflation rates,” Eitelman remarked. However, the current situation doesn’t appear to be anywhere near the magnitude of what occurred in late 2021 and 2022, he said.

“While it’s certainly true that shipping costs have gone up, particularly between Europe and China, the increase has been far less than what we saw back then,” Eitelman stated. He said that the strategist team at Russell Investments estimates that currently, shipping bottlenecks are probably only adding about one or two-tenths of a percentage point onto core inflation rates. “While that’s not zero, the impacts do look pretty modest so far,” Eitelman concluded.

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