He said, “If it turns out, central banks will have to shift their rate hike schedule from 2023 to 2022, not from 2023 to 2024 – and that is the risk in the bond market.
“Right now the two most important economic data points will be employment and, to a lesser extent, inflation. It was clear to the central banks that they expected inflation numbers above 2%. They think it’s only temporary so they won’t be overly excited, and I think that’s actually the right approach.
“You won’t fret if we hit 2.5% inflation for a few months in a row – that’s no big deal. For me, the real story here is how quickly employment will return. If this proves to be more resilient than the central bank base case, you will find that they are reducing or eliminating the forward lead that gets front-end rates moving as people start placing bets on an earlier rate hike. “
D’Costa’s own view is that rate hikes will begin in late 2022. Meanwhile, if inflation rises, it holds the promise of tension – with central banks unwavering, but the bond market likely struggling to contain concerns that it could potentially spiral out of control over the level of stimulus in the economy.
For those who gamble in the bond market, especially government bonds, there is no longer a “zero chance” that inflation will fall back to that average number of 2% if it rises above 2%. Traditional economic theory suggests that overstimulation of the economy can lead to inflation. Therefore, of course, there is a certain percentage probability that it will increase further in the 3 to 4% range.