The instances of strong threat sentiment within the face of tightening central banks are over. The top of the goldilocks market is smart and asset courses need to selected between the inflationary or recessionary situations.

The curve can value each for a time, by flattening, however we expect bonds will ultimately profit from safe-haven demand throughout the board

Inflation or recession, a well-known dilemma

What makes an power disaster inflationary quite than deflationary? That is the query traders need to grapple with as the most recent escalation of tensions between Russia and EU international locations over fee and supply of despatched power costs, particularly, on one other spike.

Again in late February/early March, the speed market’s knee-jerk response was to rally, to then shortly unload because the inflationary implications dawned on traders.

This was regardless of very actual issues in regards to the accompanied hit to consumption and confidence, to not point out the danger of additional escalation.

Stress is spreading to many corners of monetary markets

The Fed (or ECB) put doesn’t apply when inflation is running at 7% or 8%

Fast forward to today, growth concerns have spread to China where the threat of more lockdowns is compounding already fragile economic sentiment elsewhere.

The market’s blissful ignorance seems like a distant memory. Less than a week ago, it seemed nothing could stand on the market’s path towards higher rates—with obvious near-term targets at 3% and 1%, respectively, for 10Y and .

It is no coincidence that the penny dropped as central bank rhetoric goes into hawkish overdrive. Clearly, monetary policy cannot be blamed for the collapse in confidence, but there is a distinct feeling that the Fed (or ECB) put doesn’t apply when inflation is running at 7% or 8%.

Bad news is bad news, even for inflation

For now, tightening expectations have held up at the front-end of yield curves. This tends to suggest that the inflationary impact, in the near term at least, of geopolitical tensions isn’t forgotten.

Iron-clad hike expectations would mean that the long-end is more likely to reflect any growth concerns more freely, and so that the faces the risk of more bull-flattening.

This makes sense in the near term, but we doubt the market’s capacity to price both recession risk and aggressive rate hikes for long. Something has to give.

Rate hike expectations are holding up, for now

Rate Hike Expectations

Rate Hike Expectations

An even more hawkish ECB could prove unnerving for risk assets

Last week’s and CPIs are a good test of the market’s conviction. Renewed upward pressure on energy prices means that the relief of cooling CPI will prove short-lived.

We’d also argue that the focus will increasingly be on core measures to assess the broadening of price pressures, something more likely to worry the ECB than a mere energy inflation spike.

Counter-intuitively, a reading consistent with an even more hawkish ECB could prove unnerving for risk assets, and push more money into the safety of government bonds.

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