Global Rates: Central banks likely to wait-and-see against a backdrop of ongoing Middle-East uncertainty

Hi and welcome to @anyrate. J. Morgan's Global Research Podcast series, where we take a look at some of the driers behind the biggest trends and themes across fixed income, currencies and commodity markets. I'm Francis Diamond, head of European Rates Strategy here at J. Morgan, and today I'm joined by my colleagues, J. Barry, head of international rates strategy, and again, to Gupta to discuss the upcoming third B.O.E. and E.C.B. Central Bank meetings against a bad drop of the ongoing Middle East conflict. So if you look across DM rate markets, yields have risen this week with the UK underperforming cross-market. The M curves have broadly bare flattens, pretty much reflecting the rise in oil and gas prices as transport via the straight of the moves remains very limited. And I think the energy price rises as highlighted by our commodity team. Do look at it all rather limited, given the ongoing large disruption to energy supply, but maybe there's reflected fourth demand loss caused by missing supply, and even if recent media reports of potential USA run talks are correct, we think European yields are unlikely to significantly retrace lower. So maybe before we move to Europe, let's start with the USJ. And this week, US rates kept pace with the rise in rates in Europe amid the rise in energy prices, in contrast to what has been observed during early stage of the conflict. So what do you think, go over this, what's going on here? Hey, Francis, thanks so much. I think there are a couple factors here at work, which are largely domestic and nature that allowed the US to perform in line with Europe this week. First, on the margin, the consumption data were strong, and looking at the retail sales data, certainly the headline was supported by the rise in gasoline prices over the month of March, but core retail sales, which excludes autos, gas stations, and building materials, rose 0.7 tenths of a percentage point in the month of March, which is the third consecutive month of pretty solid gains. And as a function of that, the economics team has actually raised their real GDP tracking for the first quarter from 1.1% up to 1.4%. So I think that was a piece of the puzzle that spending has held in pretty well, even in the first month of the conflict. The second, I think, is related to the Fed. And Kevin Warsch, the nominee for Fed Chair, appeared before the Senate Banking Committee on Wednesday, and really were his first public comments in a number of months. And I think there has been this resting assumption for market participants that in order to secure the nomination, that Warsch will have to be dubbish and commit to lowering rates, and that he'll be able to bend the committee to his will when he walks in the door. But if anything, his comments in front of the Senate on Wednesday morning, stressed his respect for Fed independence, and he stated that the President never wants to ask him to commit to any particular interest rate decision. He also argued that it's really common that all presidents wanted lower rates, and that Fed independence is up to the Fed. So I think markets took some consolation there, and considering that he wasn't aggressively talking about lowering rates, I think this helped some of the hawkish repricing at the front end. And certainly now, OIS forward, it's basically priced the Fed on hold through late 2027. Some of this has been driven by the energy price rise that you talked about as well. Away from that, I think the other reason the curve flattened is it's been repeatedly noted that the nominee has a strong support for a smaller Fed balance sheet. And I think there's been an assumption in the markets that potentially he could restart QT and that could lend itself toward higher yields. And steeper curves, given the impact of the Fed's balance sheet on rate levels and term structure. And while he did discuss the likelihood of a smaller balance sheet, Warsh also made the point that it took 18 years to get to where we are right now. We're not going to go back in 18 months or 18 minutes. So that is likely to be deliberate in nature. I think took some of the pressure off the long end as well. This really lines with our expectation that the Fed's likely to proceed cautiously and incremental on balance sheet policy. And that restarting QT is very unlikely. Instead, I think it's more likely that if he can drive consensus on the committee later this year that perhaps reserve management purchases of T-bills and short treasury coupons just cease allowing the Fed to grow into its right-sized balance sheet instead of allowing it to continue to shrink. But we think that would need to be a accompanied alongside reform to post-Christival equity regulations like the LCR and the ILST. And we're not there yet. The Fed and the other regulators are now looking at Buzel 3N game and G-CID. And it's likely they'll deal with liquidity regulations in the fall. But either way, this is likely to be a slow process. It's likely to be passive and it's likely to be long-term in nature. So I think that's contributed to the reasons why the U of S is held in and kept pace with Europe and the move to higher rates this week. Okay. Thanks. Make sense. It's only an interesting spin on how we've seen previous weeks and market moves evolve during this conflict. So if you look at the next week, Jay and the Fed, if you look at OAS forwards, there's pretty much nothing priced in the next three meetings. So what should we be on the lookout for in terms of fake communication and direction next week, do you think? Yeah. So as you've said, markets are basically expecting nothing from the Fed and we're pricing in just a basis point or two over the next three meetings. Further from that, next weeding, next weeding, next week, there is a meeting without an SEP. So the focus will naturally just be on the post meeting statement and the press conference. We don't think there's going to be major changes to the statement as it will likely reiterate that the committee is attentive to the risks to both sides of its dual mandates. Because if we look at what's happened since the last meeting in March, the pace of employment growth certainly firmed, but it was just a single month and it's hard to call it a trend. But we do think on the margin that the Fed is likely drawing solace on the labor markets here that if we look out over the span of the last year, the unemployment rate is up only one tenth of a percentage point, despite this sharp slowing and payroll growth over that period. And with final demand pretty close to 2% over that period, it probably tells you that slowing in non-farm payrolls and particularly private payrolls is more about labor supply than about demand. But again, just because it's a single month that doesn't make a trend. And we don't think this is the meeting that PAL or the committee wants to open up the door more firmly for being attentive to the inflation side of its mandate. And this is particularly the case because this is likely to be chair PAL's last meeting. We know that his term as chair expires on May 15th, certainly at the last meeting in March, raised eyebrows where he talked about the likelihood of being president pro-tem until Kevin Warsh is confirmed. And on that front prediction markets are pricing in just about a 56% probability that Warsh will be confirmed by June 1st. And that's down from about 70% a few weeks ago. I think this is all due to the DC attorney's ongoing investigation into the Fed headquarter renovations. We know that the Senate banking committee is going to be unlikely to be able to confirm Warsh until that investigation is over. And so far, we're getting no signs from either the DC attorney or the administration that this is likely to be the case. So if this is the case, even though it's likely to be chair PAL's last meeting, we think a lot of the press conference will probably devote more to his legacy as chair in this context. And not sure that it'll be ready to break new ground on monetary policy expectations. But that being said, even though markets have priced in the Fed firmly unhold into 2027, that's in line with our forecasts. We're not sure the intermediate sector of the Treasury curve fully reflects that outcome. And I think even against this backdrop, there is some likelihood that you can see intermediate treasury yields rise, even if we get very little out of the Fed at the meeting next week. And it's not ready to make a step to open up the distribution further. Okay, thanks, Joyce. So let's turn to Europe and Figuendra, the ECB meeting next week. I mean, if we look at the recent commentary, we used to be members over the past couple of weeks, definitely the tone has been more wait and see in terms of how they calibrate or have sponsored the rise in energy prices. However, Australia, for mues, remained to be closed, rent is back above $100 per barrel. So what message do you think you speak and deliver next week? And if we look at market expectations with cumulative 60 base points of high price been into the year, you think that for instance. Yeah, thanks, Francis. I think there are two distinct things to unpack here. First, what the ECB is likely to say next week and whether what's priced into the curve is actually justified. On the first point, our base case is that the ECB keeps rates unchanged at next week's meeting, but importantly keeps the door firmly open for a June hike. The tone is likely to be one of patients and that's very much consistent with what we have heard from board members over the past couple of weeks. If you look at the commentary from the likes of Schnabel, Lagarde, Villau, the consistent theme has been that the ECB is in a relatively favorable position and does not need to rush. That said, patients is not the same as in action. ECB staff have been clear. There's below-extric correlation in wages that likely over time. And that the March staff forecast already embeds around 40 bases point of cumulative hikes by year end via their technical assumptions. Now, what reinforces the case, in my view, what is going to be a hawkish hold next week rather than an outright, Davish Privat is the fact that inflation is good driven by the inflation picture. You know where the headline inflation has already risen a little bit in March, and we expect HICP to peak around 3.2% by June. Though importantly, I think I'll highlight that code is projected by our economist who remained broadly stable around 2.2%, which in my mind is a war and it's a very significantly muted reaction from the ECB relative to what we saw in 2022. I'd like to highlight the counterweight to any hawkish signal from the ECB, of course, is on the growth side. You know, the April composite PMI came in at 48.6, consistent with the growth outlook of only around 0.4% versus what we were expecting at 1.7ish pre-war, which is a very significant downgrade if these levels of demise hold. And turning to the market pricing question, is around 60 basis point of cumulative hikes by December warranted. I do believe this is somewhat aggressive relative to our baseline. We continue to expect 225 basis point hikes in June and September. Now that said, we acknowledge the risks are not symmetric, but given recent commentary, I believe that risks are tilted towards fewer hikes rather than more from the ECB. So we like cautiously fading what is price and there's the curve, but only via options with limited downside, you know, such as flies. So in summary to your questions, we expect a patient data dependent ECB next week, a hawkish hold with June formerly in play. And with saying that 60 basis point is pretty much towards upper end of what is justified and risks medium-term are kind of skewed to the downside than from upside from here. - Okay, so that's interesting in terms of the view around ECB and AC market pricing. So maybe if we shift on to a different part of the rate complex and volatility. So compared to the peaks, we saw in late March your rate volatility has declined, but obviously uncertain to your rounds, the evolution of the Middle East conflicts to remain pretty elevated. So how do you assess the outlook for volatility across the rates curve going forward? - Sure, but before I answer, let me give you a brief background of where we currently stand in wall. Implied walls have moved higher again this week with the wall curve flattening across both tails and X-Fire is consistent with elevated near-term event driven risk by Middle East news flows. That said, I think there are early signs that the worst of the delivered volatility spike may be behind us, especially in the intermediate and long tails. If I look at, show it a realized wall on a one week or two week basis is now running meaningfully below their one one counterpart. And if near-term delivered wall continues to soften, it will open a window for imply to drift gradually lower even without a clean resolution of duplicate legal risks in my view. Now across the surface, the picture is a bit bifurcated. The subteneer implyance I'm only retraced around 30 to 40% from their March peaks, reflecting persistent ECB path and certainty. And that makes you know front end richness sticky and harder to fade. On the view on volatility, I think wall will normalize over time, maybe in the next few months, but only like I said, gradually and partially rather than snapping cleanly back to pre-conflict levels. And I think it blights will likely settle above their February averages given their structurally higher uncertainty premium around both the ECB path and the ceasefire durability. I do highlight that volatility is extremely mean reverting in nature and will normalize over the coming weeks from current elevated levels. However, rather than taking out right short wall exposure, where they're exposed to jump risk from geogradical headlines, we prefer low beta proxies, such as expiry cut steepness and more so at the long end of the curve as opposed to the front end, where we think more jump risk remains very, very elevated. Francis, let me turn it back to you on the UK. So we also have Bank of England meeting next week and recent MPC messaging has been more direct in pushing back on market pricing. However, domestic data this week has, in my view, hawkish implications for monetary policy, so what message do you expect the BIO to deliver next week? So when we look at the front end yields, we've actually seen a pretty decent repricing. We now have close to 20 base points of high price for the June meeting, cumulative closer stick for the December meeting and that compares to roughly just one high price by year and last Friday. So there's definitely been a repricing. I think when we look at the data in terms of the PMI data that's surprised to the upsides, there's seen some upshift in some of the price components of the DMP survey that the BIOE pays particular attention to. Probably it does mean inflation risks should be more relevant than gross risks for the MPC. But I think at this stage, given the move in markets, given the current market pricing, I think it's unlikely the BIOE will deliver a particularly hawkish surprise relative to where market stand. So I think the tone of the delivery next week will adopt a way to see approach in terms of waiting for clear evidence to sec around effects from the increase in energy prices since it's either conflict. But I do think, as I mentioned in terms of the shift in the DMP, we look at the CPI data, the PMI data this week, it does suggest businesses are not actually struggling to raise prices, which is contrary to the view of some of the MPC members, where they were thinking they may be some more limited pricing power from corporate moment. So I think there may be some hawkish elements, I think there may be some potential for some hawkish descent in terms of rate hike, possibly from man and pill. But I think also we need to bear in mind the BIOE's hawkish delivery in March did cause a very large repricing R in front and yields. Clearly that was coming where the conflict was an slightly different, more precarious stage in terms of hostilities that was clearly in impact from large positioning on wide. And substance comments from Bailey that you alluded to did stress that markets have probably overreacted a bit back then. So I do think the BIOE given that will be somewhat cautious in its language and approach next week. In saying that, we do think the BIOE will be hiking rates modestly, the fixed-upacet points of hike's price by the end of the year is above our forecast. I think we also have to recognize there's still relatively strong direction out to you with gas and energy prices against the backdrop of still a relative degree of uncertainty with the rate of all moves remaining closed. OK. So if I turn to the political backdrop in the UK, the upcoming local elections will likely put further pressure on Prime Minister's tarmer if the Labour Party fair has badly suggested by opinion polls currently. So do you expect you get rate markets to price increase to political risk premium? Well, it's true. We're definitely seeing politics back in the focus over the past week. PM-starrmer based increased pressure over the process of appointing Bansland to EU ambassador. And that has been played out with statements and accomplishments from him and also from a civil servant who has removed my starmer from his post. To markets will clearly keep one eye on politics as a may local elections draw closer. And yes, as you mentioned, when you look at the polling Labour is projected to lose heavily, particularly in northern metropolitan burrows where a form of support has surged, there's also Scottish and Parliament and Welsh Parliament elections where Labour is likely to lose seats as well. And if you look at the objections in terms of seats in a Parliament in the general election, a lot of the estimates suggest a form would win the largest share of seats and Labour would lose a significant number. So clearly there is pressure, but I think, although the local election to less than two weeks away, I don't think we expect the guilt curve, for example, 2010s or outright level of intermediate yields to start the price in a significant increase in political and fiscal term premium from a potential leadership challenge just yet. And the reason for that is even if Labour does perform as poorly as implied by the opinion polls, it's going to take some time for a leadership challenge to emerge. It's probably not particularly clear at the moment. There's an obvious candidate ready to launch an immediate challenge and with a backdrop of the ongoing conflict and the geopolitical situation uncertain to your round energy supply, it may not be the right time for Labour to have an internal power struggle. So even if the local elections were a catalyst for challenge to be launched, the process was still several months. It's worth noting it took 18 weeks and 16 weeks, expectively for Corbyn and Starmat to be elected as Labour party leaders in 2015 and 2020. So I think our view here is even if there's a challenge appears in the aftermath of the local elections, it's going to take some months before a new leader could be in place. And when we look at the dynamics of the guilt curve, I mean, 2010s is exhibiting a significantly increased directionality to front end yields. So basically, the main driver here is really the shifting pricing of BUE rate expectations rather than the intermediate sector and the medium term fiscal or political concern. And I think that dynamic will persist as the conflict continues, just given uncertainty around exactly how the BUE will respond through monetary policy. So I think it's a bit early to start to think about viewing the UK curve or intermediate yields through the lens of any particular fiscal or increased political risk premium for a potential leadership contest. Well, thanks, Kigendra. Thanks, Jay. That's all from us. And thank you for listening. Stay tuned for more updates on the fixed-income space here at any rate. Jayden Morgan's Global Research Podcast series. This communication is provided for information purposes only. Please read the Jayden Morgan Research reports related to its content, more information, including important disclosures. Copyright 2026, Jayden Morgan Chase and Co. All Rights reserved. This episode was recorded on 24th of April, 2026.