Stubbornly high core inflation, especially in Europe, and high-interest rates, particularly in the U.S., have convinced investors to sell the bonds they bought expecting central banks to start cutting rates soon.

Core inflation ran at 4.7 percent in the U.S. last month, 5.5 percent in Europe, and 6.8 percent in the U.K. Central banks in all three have targeted 2 percent as their inflation goal.

The bond selloff is driven by worries that a strong U.S. economy and unrelenting wage gains in Europe will keep inflation higher longer than expected, the Financial Times explained. Those worries have led investors to believe that central banks will not be able to cut interest rates as soon as previously thought.

“Most U.S. data has surprised to the upside over the past six weeks and this has had an outsize effect on bond prices,” Mike Riddell, a bond portfolio manager at Allianz Global Investors, said in an FT interview.

“You see wage pressures everywhere and they put pressure on employers to charge higher prices,” bond chief Robert Tipp at PGIM Fixed Income told the FT. “It’s just not conducive to a quick drop back to target inflation [rates].”

He sees rates lingering around 4 percent for as long as three years.

“Investors have been selling bonds recently with the view that central banks are not thinking about cuts as the labor market is tight and inflation is sticky,” bond chief Andres Balcazar at Pictet Asset Management said to the FT.

In the minutes of its most recent meeting, the U.S. Federal Reserve said for the record that there is still “significant upside risk to inflation,” a strong hint that no one should assume the bank is done raising rates.

“The narrative going into [August] was that the next big move was for lower rates but the market seems to be caught wrongfooted,” Piet Christiansen, head of fixed-income research at Danske Bank, told the FT.

With growth projected at 2 percent for the current quarter—the third in a row—“it is not clear why inflationary pressure should dissipate,” Citibank analysts wrote in a note. Bringing inflation down to central banks’ 2-percent target may need “sustained higher yields to slow the economy, and the housing sector in particular,” they warned.

Key U.S. treasury securities are returning more than 4.2 percent. Benchmark U.K. government bonds have lifted their yields by .38 of a percentage point this month. German bonds have added 0.15 of a point. Yields rise as prices fall.

Also, the U.S. treasury has announced it will issue another $1 trillion in bonds this year to fund the increased national debt. A flood of new bonds into an already weak market will drive prices down further while pushing yields higher.

Last month, Japan loosened its grip on long-term interest rates, which will allow them to move up. This could divert investors from U.S. and European securities to domestic issues.

TREND FORECAST: A majority of interest-rate futures players see the Fed holding its current rates of 5.25 and 5.5 percent until at least mid-2024; that the European Central Bank will add another quarter point to its key rate this year; and the Bank of England’s base rate will peak at 6 percent early in the new year. 

As for the U.S. interest rates, we maintain our forecast that the Federal Reserve will lower them in the run-up to the 2024 Presidential Reality Show®.