Ed Peters
February 16, 2022

Markets have been pulled between two global risks: war in Eastern Europe and inflation. The former is a geo-political risk with unknown economic consequences. The latter is more recognizable and has direct consequences for monetary policy and economic growth. For stocks, both risks can be expected to be bad news, so it’s not surprising that stocks have mostly sold off recently. But for bonds, the outlook would be quite different for the two cases.

Inflation, of course, is bad news for bonds. With real rates across the world in such negative territory, the prospect for continued high inflation and/or rate hikes by central banks would be considered bad news. But war usually benefits bonds. Political uncertainty of this magnitude typically drives a need for liquidity, which causes government bonds to rally. So the behavior of governments bonds would tell us which risk the bond market thinks is higher: (1) the risk of Russia invading Ukraine, or (2) continued high inflation and rate hikes from central banks, especially the Fed.

The path of bond yields shows us that the bond market clearly believes that inflation is a bigger risk than a potential war in Eastern Europe.1 The upward march of interest rates has barely paused in recent weeks, even after the US and UK governments said that invasion was likely any time and the US began evacuating diplomatic personnel from Kiev last week. The bond market might be wrong, of course. But that’s where its casting its vote right now.

1For those who are new to markets, bond prices and bond yields move in opposite directions. So, a rise in bond yields means that demand for bonds is lower and bond prices are falling.

Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss.
© First Quadrant, LLC, 2022. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, LLC, only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

Related Posts