Investors expect higher interest rates as inflation pressures mount

Stronger than expected US inflation and a bump in consumer spending have fuelled worldwide expectations that interest rates will go higher, as predictions about future monetary policy rapidly shift.

The Federal Reserve’s preferred measure of inflation overshot expectations in April, data published on Friday showed, while US consumer spending rose last month and new orders for long-lasting goods unexpectedly increased.

Kristalina Georgieva, the IMF’s head, on Friday warned US interest rates would need to stay higher for longer to tame inflation that had been more persistent than anticipated. She added that a loss of confidence in US Treasury markets would mean turmoil for the global economy.

Yields on short-term government debt in the US, UK and eurozone have begun to rise again as investors switch from betting on an economic slowdown to anticipating more prolonged rate increases to contend with price rises.

The shift in rate expectations marks a big change for fund managers and traders, who have spent much of the year trying to predict when central banks would start cutting interest rates.

Futures markets are now pricing in a 37 per cent chance of another interest rate rise by the Fed in June, having previously anticipated that the next move would be a cut.

The yield on two-year Treasury bonds — particularly sensitive to investors’ interest rate expectations — has risen to 4.6 per cent, from a low of 3.7 per cent earlier this month. Yields rise as prices fall.

Adding to the indications that the US economy is still moving ahead, personal consumption, adjusted for inflation, increased 0.5 per cent in April from a flat reading in March, as spending on services such as insurance and healthcare picked up.

“We keep on getting surprised by the inflation data to the upside and that is an issue,” said Florian Ielpo, head of macro at Lombard Odier Investment Managers.

Durable goods orders, which include washing machines, cars and aircraft, increased 1.1 per cent from the previous month — above economists’ expectations for a 1 per cent decline. 

Developments in US debt ceiling negotiations have also pushed US yields higher as White House negotiators seek to conclude a deal with the Republican leadership of the House of Representatives this weekend.

European and UK yields have also risen. The yield on UK two-year debt jumped as much as 0.6 percentage points this week to over 4.5 per cent, its highest level since October. The equivalent German…