Rates May Stay High For A Long Time

Interest rates are moving sharply higher globally thanks to the Federal Reserve dot plot and the European Central Bank’s hawkish message about future rate hikes. Then, unexpectedly earlier this week, the Bank of Japan piled on when it decided to raise the cap on the 10-year Japanese Government bond to 50 bps from 25 bps.

Based on the changes in rates over the past week, the ECB and BOJ have impacted bond yields the most, pushing yields in Europe and Japan sharply higher due to a significant repricing of overnight rates.

More Rates Hikes Being Priced In

Over the past week, the euro Overnight Index Swap curve has risen by around 50 bps, while Japan’s Overnight Index Swap curve rose by almost 25 bps.

The unexpected announcement by the BOJ reversed years of yield curve controls, which limited the 10-year JGB yield from rising above 25 bps. But the changes this week allow for the 10-year to now trade to high as 50 bps. As a result, the 2-Yr JGB and the 10-yr JGB have risen to levels not seen since 2015.

Big Impacts

The move by the BOJ may have had the most significant long-term impact, as the BOJ was suppressing their 10-year rate, which was serving as an anchor for rates globally. But now, the BOJ will permit the 10-year JGB rate to increase to 50 bps, allowing global rates to adjust higher or lower with the 10-year JGB. The unexpected policy change also dramatically weakened the dollar vs. the yen.

Additionally, expectations for more rate hikes following the tough talk at the ECB press conference sent yields sharply higher across Europe. The German 2-year has climbed to over 2.6%.

US Treasuries were not in isolation as they rose sharply this past week, with the most significant impact coming on the long end of the curve. The 10-year and 30-year climbed by almost 25 bps.

The End Of An Era

The moves by ECB last week and the BOJ this week mean the era of negative interest rate policy that has been in place for years is coming to an end. More importantly, it would indicate we will be entering a higher-rate environment overall. How high rates ultimately go will depend on how quickly inflation cools and, more importantly, how much growth slows in response to this shift in monetary policy.

It also means that the floor for monetary policy is probably higher than what it was over this past decade and could very well mean that the days of QE are over, as it appears that central banks are now fully aware of the effects QE can have when pushed too hard.

What’s very clear is that heading into 2023, central banks will be far more hawkish and in better alignment than previously thought, which will result in higher rates than what had been previously priced in by the market.