War Risk, Liquidity Squeeze Spur Bets on a Less Aggressive Fed

The bond market is dialing back expectations for how quickly and steeply the Federal Reserve will raise interest rates as Russia’s war in Ukraine threatens to exert a drag on global economic growth.

Money-market traders have priced out any risk that the U.S. central bank will start its tightening campaign this month with a half-point increase, which was once seen as a near certainty, and even a quarter-point move isn’t completely assured. At the same time, they have also marked down where the Fed’s benchmark rate will peak to around 1.7%, a drop of over 20 basis points from previous expectations and well short of the central bank’s 2.5% long-term estimate for the rate.

The repricing shows how much the geopolitical uncertainty has shifted the balance of risks facing the world’s monetary-policy makers, who now need to weigh the prospects of slower growth even as rising energy and commodity prices threaten to fuel what’s already the highest inflation in four decades. The move in U.S. markets is being mirrored in the U.K. and Europe, where traders have also dialed back rate-hike bets.

“This is a significant increase in the stagflationary winds blowing through the global economy,” Mohamed El-Erian, chief economic adviser at Allianz SE and a Bloomberg Opinion columnist, said on Bloomberg Television. “The marketplace has been coming down to a more reasonable amount of tightening. But what the marketplace hasn’t recognized is the reason why the Fed will tighten less. It’s not because inflation has a better outlook. It has a worse outlook. It’s because growth has a significantly worse outlook for the global economy.”