Markets bet central bankers will soon end inflation crusade

As a result, bond markets are now trimming their expectations for future Fed rate hikes.

The yield on two-year US bonds – which is most sensitive to future Fed rate rises – slid by 22 basis points last week 2.84 per cent, and is now 60 basis points below its peak in mid-June.

Similarly, the yield on benchmark US 10-year bonds dropped 24 basis points last week to 2.89 per cent, a sharp fall from its peak of 3.48 per cent almost three weeks ago.

The bad news for highly geared households and businesses, however, is it is likely to take some time for central bankers to change tack.

As a result, they’ll face further tightening pain in the short term.

Economists expect Fed officials will raise interest rates by 75 basis points at its meeting towards the end of the month.

Similarly, the Reserve Bank board is likely to raise interest rates by 50 basis points at its meeting on Tuesday.

Reserve Bank boss Philip Lowe last month warned people should be prepared for more pain in coming months, as the central bank stepped up its efforts to rein in inflation, which he expects to peak at a “very high” 7 per cent late this year.

Most economists believe a 50 basis point rate hike would help to emphasize Lowe’s point that inflation is a serious problem, and that interest rates are inevitably headed higher.

But central bankers’ laser-like focus on inflation will inevitably land them in perilous waters. As consumer and business confidence crumbles, and asset prices tumble, they’ll have to start providing more monetary stimulus – even if they haven’t succeeded in driving inflation back down to target.

That’s because the warnings of a vicious global economic slowdown are getting louder.

Commodity markets have seen a wave of selling, which has seen the price of copper fall below $US8000 for the first time in almost 18 months.

The industrial metal, often dubbed Dr Copper for its ability to predict major economic trends, has fallen as investors have worried demand in the developed countries is shrinking sharply.

The sell-off in copper prices marks a sharp contrast to earlier this year, when booming demand push the price of copper above $US10,600 a tonne. Prices for other metals, from aluminum to zinc, have also dropped.

As a result, industrial metals have suffered their worst quarter since the 2008 financial crisis.

Not surprisingly, the sell-off in commodity markets coincides with a slowdown in global manufacturing activity. From the United States to the eurozone, activity at factories slowed to levels last seen in the early days of the pandemic, as soaring inflation and rising interest rates made consumers wary of spending.

Activity in the US manufacturing sector expanded at the slowest pace in two years in June, according to the Institute for Supply Management’s purchasing managers’ index.

New orders fell for the first time in two years as customer demand softened, while employment in the manufacturing sector fell for the second consecutive month, after expanding for eight straight months.

The picture was equally bleak in the eurozone, where manufacturing output fell to its weakest level since August 2020, according to S&P Global.

And there was little sign of respite, with new orders falling at the fastest pace since May 2020,

Meanwhile, Asian business that benefitted from the pandemic boom in demand for working-from-home equipment – ​​which resulted in soaring sales of goods such as laptops and office furniture – are now struggling with weakening demands.

Official figures show South Korea’s export growth slowed sharply in June, partly as a result of softer global demand.

One exception to the pattern was China, where factory activity picked up in June, after three months of declines caused by the strict COVID lockdowns in Shanghai and other major cities.

All the same, some analysts were disappointed the recovery wasn’t more robust. The official manufacturing purchasing managers’ index (PMI) climbed to 50.2 in June, leaving it only slightly above the 50-point level that separates contraction from growth.

There are already signs softening global demand is taking some of the heat out of inflation.

The US Commerce Department’s index of consumer prices – the Fed’s preferred measure of inflation – rose 0.6 per cent in May from April, putting it 6.3 per cent above its level a year ago.

Core prices – which exclude volatile food and energy prices – rose 0.3 per cent from a month earlier, and were up 4.7 per cent in the year. Both measures were better than economists had expected, and suggest inflationary pressures are abating.

Already, the prices of some pandemic essentials – such as furniture and appliances – are wilting as workers return to the office. And analysts are warning over-stocked retailers, such as Target and Walmart, will have little choice but to start cutting prices to clear bloated inventors.

The combination of dwindling consumer demand and the easing of many supply chain blocks will mean central bankers are likely to see some easing in inflation pressures later this year.

Investors are betting this will be enough for central bankers to call a halt to their assault on rate hikes, even though inflation won’t have been completely tamed.

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