Trading Desk Talk

Try Everything

Disney’s beloved furry animated cops, Judy Hopps and Nick Wilde, worked through their clashing personalities in the Zootopia movie series. The sequel focuses on unearthing a misunderstood reptile city beyond the weather walls while maintaining the goal of a utopian society, among threats and villains. In a way, the current geopolitical landscape isn’t too dissimilar. This past week’s spotlight was on the clash between Fed Chair Jerome Powell, President Trump, and bond vigilantes, amid a backdrop of war abroad. In his latest tussle with the president, Powell may have borrowed a couple of bars from Shakira, who sang “I won’t give up, no, I won’t give in, ‘til I reach the end, and then I’ll start again. No, I won’t leave, I wanna try everything, I wanna try even though I could fail” in her theme song “Try Everything.”

Bond volatility has been on the rise after reaching its local nadir on January 26. While the current war in Iran began on February 28, the bond markets showed angst in the lead up to the conflict. Since then, fixed-income investors have begun to price additional risk premia, evidenced by the MOVE Index (Figure 1), but also in corporate bond credit default swap spreads and option adjusted spreads. Similarly, stock prices for the S&P 500 fell about 5% from the peak reached in late January.

Just a few weeks ago, the market was priced for perfection—with stocks at all-time highs, corporate spreads at lows, and a Federal Open Market Committee primed to deliver rate cuts, given slowing dynamics in the labor market. That has all changed now. Inflationary fears have crept into the minds of investors and global monetary policymakers, leaving uncertainty to drive the rates sell-off and risk-off tone.

Short-term government yields spiked last week, as central bankers broadly signaled unease with their respective inflation forecasts triggered by war in the Middle East. Two-year Treasury yields closed the week at 3.90% after Powell signaled that the Fed may keep rates steady all year. The inflationary climate forced a hawkish mantra among other central bankers as well (Figure 2). U.K. two-year Gilt yields surged to 4.57%, after the Bank of England said it “stands ready” to prevent inflation from accelerating. Equivalent German Bund yields rose by about 30 basis points from March 17, to close the week at 2.67%, as traders stuck to bets that the European Central Bank will raise rates at least twice this year.

Some central banks have already embarked on a hiking cycle. The Reserve Bank of Australia raised rates last week, increasing the cash rate target from 3.85% to 4.10%. The five-to-four voting decision in favor of a hike marked the second consecutive meeting with an increase in policy rate, alongside echoes of rising energy costs pressuring already stubborn inflation.

Meanwhile, the Bank of Japan reiterated its intention to raise the benchmark rate if its inflation outlook materializes. The hawkish tone was evident following board member Hajime Takata’s second consecutive dissent, where he again called for a rate hike; Takata said that risks to prices in Japan were skewed to the upside due to the second-round impact of price rises stemming from developments overseas. BOJ Governor Kazuo Ueda also said that more board members noted the upside risks for prices during the central bank’s latest two-day meeting.

Similarly, in Europe, ECB Governing Council member Joachim Nagel said the central bank will consider raising interest rates as soon as April if war continues to cause pricing pressure. “It is conceivable that the medium-term inflation outlook could deteriorate and inflation expectations could rise on a sustained basis, meaning that a more restrictive monetary-policy stance would probably be necessary.” Money markets forecast three quarter-point hikes by the ECB this year.

In short, global inflationary fears are rising as a result of the Iran war, including the respective economic idiosyncrasies with energy costs that need to be addressed at the country level. For example, Japan is among the major economies most vulnerable to the fallout, with more than 90% of oil imports coming from the Middle East. Gasoline prices jumped to ¥190.8 per liter this week, the most expensive in data going back to 1990, according to a government report. Due to this reliance, the BOJ will likely be more vigilant than others to try to arrest inflationary pressures. The ECB, likewise, is more sensitive because the European Union also gets a significant amount of its crude oil, natural gas, and related products from the Middle East.

“There was a consensus view that this [war with Iran] was going to be over relatively quickly,” said Brij Khurana, portfolio manager at Wellington Management. “The fear is now finally in the market that this could last a lot longer.” John Briggs, head of U.S. rates strategy at Natixis North America, added: “As long as the war is in escalation mode and not de-escalation mode, the market will be more worried about inflation than growth, and reasonably so, given recent history of supply shocks.” Figure 3 charts inflation rates for the U.S., Eurozone, Japan, U.K., and Australia. While the trends have so far been benign, albeit above target, the risks are clearly to the upside.

“Central banks are beginning to address the prospect of higher inflation by adjusting their guidance and biases away from interest rate cuts and toward hikes,” noted Thierry Wizman, global FX and rates strategist at Macquarie Group. “They [central banks] have so far consistently tilted toward the premise that they should worry more about the inflationary impact of the energy shock than the possible impact on unemployment.”

Returning to the U.S., less than three weeks ago, the market was expecting the Fed to cut rates twice this year. But as of the market close on Friday, a hike is now anticipated (Figure 4).

While other countries may be more willing to hike rates in short order, America does not have this same impetus. “Having a central bank with a dual mandate does make the U.S. different,” said Gargi Chaudhuri, chief investment and portfolio strategist for the Americas at BlackRock. The Fed is “more likely to focus on the growth shock and easing policy rates,” argued Chaudhuri. The U.S. also has the luxury of being a net exporter of oil, natural gas, and related products—and, therefore, is more insulated from energy price spikes than most European and Asian countries.

Today’s crosscurrents between labor and inflation are ebbing and flowing at varying speeds for all countries. In this highly volatile environment, central bankers need to be both vigilant and methodical to weather the storm. Fortunately, policymakers have more measured options at their disposal before they must, as Shakira urged, “try everything.”

FROM THE DESK

Agency CMBS — John Briggs, quoted above, suggests that, given ongoing shocks, “it is a good time to head for the sidelines to re-evaluate when the dust settles.” While we don’t expect our investors to fully sideline themselves, we wouldn’t be surprised to see them adopt a more risk-averse tone. Indeed, we saw a lot of secondary MBS offers on the Fannie Mae and Freddie Mac side of the business—but no bids, signaling some lack of demand.

Municipals — AAA tax-exempt yields moved higher across the curve, week over week. The market sold off toward the end of the week, as many investors decided to sit on cash and see what next week brings in terms of rates and market volatility. No great surprise there: Portfolio managers have less incentive to put cash to work today when they think yields will be higher tomorrow. Municipal bond funds recorded inflows of $1.8 billion last week ($650 million of which went to high-yield funds), marking the twelfth consecutive week of inflows and bringing the year-to-date total to $16.6 billion. Average weekly inflows in 2026 are around $1.4 billion.

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