Financial news last week was dominated by a sharp sell-off in bond markets around the world.
Key points:
➢ Polish data raise concerns — growth disappoints while inflation rises.
➢ The USD strengthens against other major currencies amid a global bond market sell-off.
➢ Following high inflation readings in the US, markets are pricing in a Fed rate hike in 2026.
➢ The war in Iran continues, with the parties failing to negotiate an agreement on the key disputed issues.
➢ Andy Burnham becomes the favourite to become prime minister, while the UK bond market suffers heavy losses.
Bondholders were unsettled by a combination of factors: the prospect of energy prices remaining higher for longer, evidence of second-round inflation effects, and political instability in countries such as the United Kingdom. More difficult to quantify, but still present in the back of every investor’s mind, are the lack of progress in reducing deficits in developed economies and the prospect of never-ending issuance of new debt securities — a trend exacerbated everywhere by demographics.
Equities have remained relatively resilient in the face of the sharp rise in yields. Currencies, however, have not. All major currencies weakened against the dollar, with the British pound and the Brazilian real performing particularly poorly due to domestic political difficulties.
The macroeconomic calendar for this week is relatively light. This means that observing the market’s reaction to the bond sell-off may prove instructive: will bonds find a bottom and rebound, or will the sell-off continue in the absence of fresh news? Attention this week will focus on the global release of PMI business activity indicators on Thursday, 21 May. From the United Kingdom, labour market data will be published on Tuesday, 19 May, followed by inflation data on Wednesday, 20 May. The most important issue, however, will remain the uncertain future of Prime Minister Keir Starmer.
PLN
Market concerns over the prolonged conflict in the Middle East are weakening the zloty, which has returned to around 4.25 against the euro. Local news has not been particularly encouraging either. Last week’s first-quarter GDP data disappointed: growth of just 0.5% quarter on quarter was half the pace recorded in the fourth quarter and weaker than the expected 0.6–0.7%. These are not positive figures, although it is worth remembering the unfavourable circumstances: weak eurozone activity, the energy shock and a cold winter.
At this stage, it does not seem appropriate to speak of inherent weakness in the economy. Nevertheless, some concern is also raised by the detailed inflation data released in recent days. Despite government shielding measures, price growth reached 3.2% in April. Particularly noteworthy were the rapid increase in prices in the “information and communication” category, very strong growth in air transport prices, and the rise in core inflation to 3.0%.
This week, we will pay attention to April labour market data, especially wages, as labour market tightness is crucial in the context of the risk of second-round effects. Industrial production and producer inflation data, due on Thursday, 21 May, will also be important. Normally, the latter would not attract much attention, but amid the energy shock and the huge surprise in the corresponding US data, they have gained significance. Although the consensus points to a slightly negative reading, it cannot be ruled out that, after nearly three years, producer price deflation will come to an end.
EUR
The bond sell-off spread to the short end of the US yield curve, which means that over the past two weeks the interest-rate differential on the two sides of the Atlantic has not narrowed further. We see this as one of the factors driving the recent weakening of the euro against the dollar. Two other factors are the natural flight to safe-haven assets caused by the war in Iran and the fact that the jump in energy prices appears to be hitting the European economy much harder than the US economy.
We are awaiting preliminary PMI indicators for May, due on Thursday, 21 May, to see whether higher energy prices are having a sustained impact on business activity in the bloc. Economists expect a slight increase in the composite index, though still to levels consistent with economic contraction. We suspect that the second quarter will be a period of effective stagnation, although a scenario of negative growth during this period cannot be ruled out.
USD
Several unpleasant surprises in US data releases for April intensified the bond market sell-off that had begun in the United Kingdom. Consumer inflation rose more strongly than expected, and price pressure appears to be spreading from the energy sector into the core index. Producer prices also significantly exceeded forecasts, as inflationary pressure spreads through the supply chain. Talk of US interest-rate cuts has almost completely ceased, while markets are increasingly confident that the next move will be a hike — the main uncertainty is exactly when it will happen.
An important aspect of the ongoing bond sell-off is that market-implied longer-term inflation expectations are beginning to rise, which is a worrying development for the Federal Reserve. Last week, Kevin Warsh was officially appointed as the new chair of the FOMC and will preside over his first Fed meeting in June. We believe it will be difficult for him to win over any hawks, meaning that investors’ main concern will probably become his desire to abandon forward guidance.
GBP
The bond market sell-off began in the United Kingdom amid concerns that, following Labour’s defeat in local elections, Starmer’s cabinet could be replaced by an even more fiscally irresponsible government. It then quickly spread to other G10 economies. As a result, the pound weakened against other major currencies last week. The only consolation for sterling is that economic data remain fairly solid. In the first quarter, the economy grew by 0.6%, while PMI indicators so far show a relatively limited impact from uncertainty related to the war in Iran.
A series of data releases this week will test this narrative. We are particularly awaiting the reaction of business confidence to political instability. The pound has suffered such a sharp sell-off that its valuation already reflects a significant degree of political instability. Nevertheless, a further shift of the government to the left would probably deepen it.
Andy Burnham, the Mayor of Greater Manchester, who would first have to win the Makerfield seat, is currently the bookmakers’ favourite to replace Starmer. Given both his support for higher borrowing and taxes, as well as his previous statements downplaying the need for the government to submit to the bond market, we believe his selection would be the worst-case scenario for government bonds and the pound.
The information contained in this document is for informational purposes only. It does not constitute financial advice or any other form of advice, is general in nature and is not addressed to any specific recipient. Before using this information for any purpose, independent advice should be sought.
Authors: Enrique Díaz-Alvarez, Matthew Ryan and Roman Ziruk – Ebury analysts
