Treasuries led losses in global bond markets as inflation concerns, stoked by soaring oil prices, overshadowed any haven bids on the back of Russia-related tensions.
Ten-year U.S. yields traded at 1.94% as of 7:32 a.m. in New York, reversing an earlier decline to a two-week low. Two-year Treasury rates jumped five basis points to 1.52%, set for the biggest increase in a week. U.S. markets reopened on Tuesday after shutting for a holiday.
U.S. and European governments threatened new sanctions on Russia, while the U.K. said it will sanction five Russian banks and three high net-worth individuals after Russian President Vladimir Putin recognized two self-proclaimed separatist republics in eastern Ukraine and ordered troops sent to them.
While the escalation in tensions initially buoyed bonds, that move reversed as Brent advanced toward $100, which propelled some market-based inflation gauges to multi-year highs. Central banks will weigh the impact of any cost shock arising from the tensions on demand and inflation against the risk of second-round effects of rising wages, according to Karen Ward, chief market strategist for EMEA at JPMorgan Asset Management.
“What the market is saying at the moment is there are risks of those second-round effects,” Ward said on Bloomberg Television. “This is not a cost shock that’s hitting weak economies.”
Inflation Concerns
Russian assets also staged a turnaround, with surging energy prices benefitting the oil-exporting nation. The ruble rallied 1% after hitting the weakest since November 2020, while the benchmark MOEX index trimmed losses to 1.7% from as much as 9.2%. Meanwhile, U.K. 10-year breakevens -- a bond market gauge of inflation risk -- rose to the highest reading since 1996.
“A rise in oil prices due to tensions does not make the inflation outlook any easier for policy makers,” said Tony Morriss, head of Australian & New Zealand economics and rates strategy at Bank of America.
Swaps traders signaled the latest escalation has done little to alter the assumption that the Federal Reserve will raise interest rates at most of the seven meetings left in 2022.
A 25-basis point hike next month is baked in, and markets still see more than a 20% chance for a 50-basis point move at the meeting. Fed Governor Michelle Bowman suggested that a half percentage-point increase could be on the table if incoming readings on inflation come in too high.
Traders are pricing in six 25-basis-point hikes for the full year. This compares with earlier expectations for seven increases in 2022, with much of the shift centering on Fed rhetoric which has sought to strike a balance between curbing inflation and supporting employment growth.