Global Rates: Central banks likely to wait-and-see against a backdrop of ongoing Middle-East uncertainty

Hi and welcome to At Any Rate, Jay F. Morgan's global research podcast series where we take a look at some of the drivers behind the biggest trends and themes across fixed income, currencies and commodity markets. I'm Francis Diamond, Head of European Rates Strategy here at Jay F.

Morgan and today I'm joined by my colleagues Jay Barry, Head of International Rates Strategy. Thank you again to Gupta to discuss the upcoming Fed, BOE and ECB central bank meetings against the backdrop of the ongoing Middle East conflict. So if you look across DM rate markets, yields have risen this week with the UK underperforming cross market.

DM curves have broadly bear flattened, pretty much reflecting the rise in oil and gas prices as transport via the Strait of Hormuz remains very limited. And I think the energy price rises as highlighted by our commodities team do look a little rather limited given the ongoing large disruption to energy supply. But maybe there's a reflected fourth demand bluff caused by missing supply.

And even if recent media reports of potential US Iran talks are correct, we think European yields are unlikely to significantly retrace lower. So maybe before we move to Europe, let's start with the US, Jay. And this week, US rates kept pace with the rise in rates in Europe amid the rise in energy prices, in contrast to what has been observed during early stages of the conflict.

So what do you think drove this? What's going on here? Hey, Francis, thanks so much.

I think there are a couple of factors here at work, which are largely domestic in nature that allowed the US to perform in line with Europe this week. First, on the margin, the consumption data were strong. And looking at the retail sales data, certainly the headline was supported by the rise in gasoline prices over the month of March.

But core retail sales, which excludes autos, gas stations and building materials, rose 0.7% of a percentage point in the month of March, which is the third consecutive month of pretty solid gains. And as a function of that, the economics team has actually raised their real GDP tracking for the first quarter from 1.1% up to 1.4%. So I think that was a piece of the puzzle.

That spending has held in pretty well, even in the first month of the conflict. The second, I think, is related to the Fed. And Kevin Warsh, the nominee for Fed chair, appeared before the Senate Banking Committee on Wednesday and really were his first public comments in a number of months.

And I think there has been this resting assumption for market participants that in order to secure the nomination, that Warsh will have to be dovish and commit to lowering rates and that he'll be able to bend the committee to his will when he walks in the door. But if anything, his comments in front of the Senate on Wednesday morning, you know, stressed his respect for Fed independence. And he stated that the president never once asked him to commit to any particular interest rate decision.

He also argued that it's really common that all presidents wanted lower rates and that Fed independence is up to the Fed. So I think markets took some consolation there. And considering that he wasn't aggressively talking about lowering rates, I think this helped some of the hawkish repricing at the front end.

And certainly now OIS forwards basically price the Fed on hold through late 2027. Some of this has been driven by the energy price rise that you talked about as well. Away from that, I think the other reason the curve flattened is it's been repeatedly noted that the nominee has a strong support for a smaller Fed balance sheet.

And I think there's been an assumption in the markets that potentially he could restart QT and that could lend itself toward higher yields and steeper curves given the impact of the Fed's balance sheet on rate levels and term structure. And while he did discuss the likelihood of a smaller balance sheet, Warsh also made the point that it took 18 years to get to where we are right now. We're not going to go back in 18 months or 18 minutes.

So that is likely to be deliberate in nature, I think, took some of the pressure off the long end as well. This really aligns with our expectation that the Fed is likely to proceed cautiously and incremental on balance sheet policy and that restarting QT is very unlikely. Instead, I think it's more likely that if he can drive consensus on the committee later this year, that perhaps reserve management purchases of T-bills and short treasury coupons just cease, allowing the Fed to grow into its right size balance sheet instead of allowing it to continue to shrink.

But we think that would need to be accompanied alongside reform to post-crisis liquidity regulations like the LCR and the ILST. And we're not there yet. The Fed and the other regulators are now looking at Basel III endgame and G-SIB, and it's likely they'll deal with liquidity regulations in the fall.

But either way, this is likely to be a slow process. It's likely to be passive and it's likely to be long-term in nature. So I think that's contributed to the reasons why the U.S. has held in and kept pace with Europe in the move to higher rates this week.

Okay, thanks. Makes sense. It's certainly an interesting spin on how we've seen previous weeks and market moves evolve during this conflict.

So if we look ahead to next week, Jay, and the Fed, if we look at OAS forwards, there's pretty much nothing priced in the next three meetings. So what should we be on the lookout for in terms of communication and direction next week, do you think? Yeah.

So as you've said, markets are basically expecting nothing from the Fed, and we're pricing in just a basis point or two over the next three meetings. Further from that, next week, there is a meeting without an SEP. So the focus will naturally just be on the post-meeting statement and the press conference.

We don't think there's going to be major changes to the statement, as it will likely reiterate that the committee is attentive to the risks to both sides of its dual mandates. Because if we look at what's happened since the last meeting in March, the pace of employment growth certainly firmed, but it was just a single month, and it's hard to call it a trend. But we do think on the margin that the Fed is likely drawing solace on the labor markets here, that if we look out over the span of the last year, the unemployment rate is up only one-tenth of a percentage point, despite this sharp slowing in payroll growth over that period.

And with final demand pretty close to 2% over that period, it probably tells you that slowing in non-farm payrolls, and particularly private payrolls, is more about labor supply than about demand. But again, just because it's a single month, it doesn't make a trend. And we don't think this is the meeting that Powell or the committee wants to open up the door more firmly for being attentive to the inflation side of its mandate.

And this is particularly the case because this is likely to be Chair Powell's last meeting. We know that his term as Chair expires on May 15th. Certainly at the last meeting in March, it raised eyebrows where he talked about the likelihood of being President pro tem until Kevin Warsh is confirmed.

And on that front, prediction markets are pricing in just about a 56% probability that Warsh will be confirmed by June 1st, and that's down from about 70% a few weeks ago. I think this is all due to the D.C. Attorney's ongoing investigation into the Fed headquarter renovations.

We know that the Senate Banking Committee is going to be unlikely to be able to confirm Warsh until that investigation is over. And so far, we're getting no signs from either the D.C. Attorney or the administration that this is likely to be the case.

So if this is the case, even though it's likely to be Chair Powell's last meeting, we think a lot of the press conference will probably devote more to his legacy as Chair in this context and not sure that it'll be ready to break new ground on monetary policy expectations. But that being said, even though markets have priced in the Fed firmly on hold into 2027, that's in line with our forecasts, we're not sure the intermediate sector of the Treasury curve fully reflects that outcome. And I think even against this backdrop, there is some likelihood that you could see intermediate Treasury yields rise, even if we get very little out of the Fed at the meeting next week, and it's not ready to make a step to open up the distribution further.

OK, thanks, Joe. So let's turn to Europe and Uganda, the ECB meeting next week. I mean, if we look at the recent commentary from ECB members over the past couple of weeks, definitely the tone has been more wait and see in terms of how they calibrate a response to the rise in energy prices.

However, Australia Hormuz remains effectively closed. Brent is back above $100 per barrel. So what message do you think ECB can deliver next week?

And if we look at market expectations with cumulative 60 base points of hikes priced at the end of the year, do you think that's warranted? Yeah, thanks, Francis. You know, I think there are two distinct things to unpack here.

First, what the ECB is likely to say next week and whether what's priced into the curve is actually justified. On the first point, our base case is that the ECB keeps rates unchanged at next week's meeting, but importantly, keeps the door firmly open for a June hike. The tone is likely to be one of patience, and that's very much consistent with what we have heard from board members over the past couple of weeks.

If you look at the commentary from the likes of Schnabel, Lagarde, Villalba, the consistent theme has been that the ECB is in a relatively favourable position and does not need to rush. That said, patience is not the same as inaction. ECB staff have been clear, the spillover to core inflation and wages are likely over time.

And then the March staff forecast already embeds around 40 basis point of cumulative hikes by year-end, via their technical assumptions. Now, what reinforces the case, in my view, what is going to be a hawkish hold next week, rather than an outright dovish pivot, is the fact that inflation is driven by the inflation picture. You know, the headline inflation has already risen a little bit in March, and we expect HICP to peak around 3.2 per cent by June, though importantly, I think I'll highlight that core is projected by our economists to remain broadly stable around 2.2 per cent, which in my mind warrants a very significantly muted reaction from the ECB relative to what we saw in 2022.

I'd like to highlight that the counterweight to any hawkish signal from the ECB, of course, is in the growth side. You know, the April composite PMI came in at 48.6, consistent with a growth outlook of only around 0.4 per cent versus what we were expecting at 1.7-ish pre-war, which is a very significant downgrade if these levels of PMIs hold. Now, turning to the market pricing question, is around 60 basis point of cumulative hikes by December warranted?

I do believe this is somewhat aggressive relative to our baseline. We continue to expect two 25 basis point hikes in June and September. Now, that said, we acknowledge the risks are not symmetric, but given recent commentary, I believe that risks are tilted towards fewer hikes rather than more from the ECB.

So, we like cautiously fading what is priced in the ester curve, but only via options with limited downside, you know, such as flies. So, in summary to your questions, we expect a patient data-dependent ECB next week. A hawkish hold with June firmly in play, and we think the 60 basis point is pretty much towards upper end of what is justified, and risks medium-term are kind of skewed to the downside than from upside from here.

Okay, so that's interesting in terms of the view around ECB and how you see market pricing. Maybe if we shift on to a different part of the rates complex and volatility. So, compared to the peaks we saw in late March, Euro rate volatility has declined, but also uncertainty around the evolution of the Middle East conflicts still remains pretty elevated.

So, how do you assess the outlook for volatility across the rates curve going forward? Sure, but before I answer, let me give you a brief background of where we currently stand in vol. Implied vols have moved higher again this week with the vol curve flattening across both tails, and expiry is consistent with elevated near-term event-driven risk by Middle East news flows.

That said, I think there are early signs that the worst of the delivered volatility spike may be behind us, especially in the intermediate and long tails. If I look at short-dated realized vol on a one-week or two-week basis is now running meaningfully below their one-month counterpart. And if near-term delivered vol continues to soften, it will open a window for implieds to drift gradually lower, even without a clean resolution of geopolitical risks in my view.

Now, across the surface, the picture is a bit bifurcated. The sub-tenured implieds have only retraced around 30 to 40% from their March peaks, reflecting persistent ECB path uncertainty. And that makes, you know, front-end richness sticky and harder to fade.

On the view on volatility, I think vol will normalize over time, maybe in the next few months, but only, like I said, gradually and partially rather than snapping cleanly back to pre-conflict levels. And I think implieds will likely settle above their February averages, given their structurally higher uncertainty premium around both the ECB path and the ceasefire durability. I do highlight that volatility is extremely mean-reverting in nature and will normalize over the coming weeks from current elevated levels.

However, rather than taking outright short-vol exposure where, you know, they're exposed to jump risk from geopolitical headlines, we prefer, like, low-beta proxies, such as expiry-cut steepness, and more so at the long end of the curve, as opposed to the front-end, where we think jump risk remains very, very elevated. Francis, let me turn it back to you on the UK. So, we also have Bank of England meeting next week, and recent MPC messaging has been more direct in pushing back on market pricing.

However, domestic data this week has, in my view, hawkish implications for monetary policy. So, what message do you expect the BOE to deliver next week? So, when we look at the front-end yields, we've actually seen a pretty decent repricing.

We now have close to 20 base points of hikes priced for the June meeting, cumulative close to 60 for the December meeting, and that compares to roughly just one hike priced by year-end last Friday. So, there's definitely been a repricing. I think when we look at the data in terms of the PMI data to price the upsides, there's been some upshift in some of the price components of the DMP survey that the BOE pays particular attention to.

Probably, it does mean inflation risks should be more prevalent than gross risks for the MPC. But I think at this stage, given the move in markets, given the current market pricing, I think it's unlikely the BOE will deliver a particularly hawkish surprise relative to where markets stand. So, I think the tone of the delivery next week will adopt a wait-and-see approach in terms of waiting for clear evidence of second-round effects from the increase in energy prices since the start of the conflict.

But I do think, as I mentioned, in terms of the shift in the DMP, we look at the CPI data, the PMI data this week, it does suggest businesses are not actually struggling to raise prices, which is contrary to the view of some of the MPC members, where they were thinking there may be some more limited pricing power from corporates at the moment. So, I think there may be some hawkish elements. I think there may be some potential for some hawkish descent in terms of rate hike, possibly from man and pill.

But I think also we need to bear in mind the BOE's hawkish delivery in March did cause a very large repricing higher in front-end yields. Clearly, that was coming where the conflict was in a slightly different, more precarious stage in terms of hostilities. There was clearly an impact from large positioning unwind.

And some comments from Bailey that he alluded to did stress that markets had probably overreacted a bit back then. So, I do think the BOE, given that, will be somewhat cautious in its language and approach next week. In saying that, we do think the BOE will be hiking rates modestly.

The 60 basic points of hikes priced by the end of the year is above our forecast. I think we also have to recognise there's still relatively strong directionality with gas and energy prices against the backdrop of still a relative degree of uncertainty with tradeable moves remaining closed. Okay.

So, if I go to the political backdrop in the UK, the upcoming local elections will likely put further pressure on Prime Minister Starmer if the Labour Party fare as badly as suggested by opinion polls currently. So, do you expect UK markets to price increased political risk, Premier? Well, it's true.

We've definitely seen politics back into focus over the past week. PM Starmer faced increased pressure over the process of appointing Manson to EU ambassador. And that has been played out with statements in the comments from him and also from a civil servant who was removed by Starmer from his post.

So, markets will clearly keep one eye on politics as the May local elections draw closer. And yes, as you mentioned, when you look at the polling, Labour is projected to lose heavily, particularly in northern metropolitan boroughs where reform support has surged. There's also Scottish and Welsh parliament elections where Labour is likely to lose seats as well.

And if you look at the projections in terms of seats in a parliament in the general election, a lot of the estimates suggest reform would win the largest share of seats and Labour would lose a significant number. So, clearly, there is pressure. But I think, although the local elections are less than two weeks away, I don't think we expect the gilt curve, for example, Tuesdays or outright level of intermediate yields to start the price in a significant increase in political fiscal term premium from a potential leadership challenge just yet.

And the reason for that is even if Labour does perform as poorly as implied by the opinion polls, it's going to take some time for a leadership challenge to emerge. It's probably not particularly clear at the moment. There's an obvious candidate ready to launch an immediate challenge.

And with the backdrop of the ongoing conflict and the geopolitical situation, uncertainty around energy supply, it may not be the right time for Labour to have an internal power struggle. So even if the local elections were a catalyst for a challenge to be launched, the process will still take several months. It's worth noting it took 18 weeks and 16 weeks respectively for Corbyn and Starmer to be elected as Labour Party leaders in 2015 and 2020.

So I think our view here is even if there's a challenge appears in the aftermath of the local elections, it's going to take some months before a new leader could be in place. And when we look at the dynamics of the gilt curve, I mean, Tuesday's 10s is exhibiting a significantly increased directionality to front-end yields. So basically, the main driver here is really the shifting pricing of BOE rate expectations rather than the intermediate sector and any of the medium-term fiscal or political concerns.

And I think that dynamic will persist as the conflict continues, just given uncertainty around exactly how the BOE will respond through monetary policy. So I think it's a bit early to start to think about viewing the UK curve or intermediate yields through the lens of any particular fiscal or increased political risk premium from a potential later leadership contest. Well, thanks, Kigendre.

Thanks, Jay. That's all from us. And thank you for listening.

Stay tuned for more updates on the fixed income space here on At Any Rate, J.P. Morgan's global research podcast series. This communication is provided for information purposes only.

Please read the J.P. Morgan research reports related to its content. More information including important disclosures.

Copyright 2026, J.P. Morgan Chase & Co., All Rights Reserved. This episode was recorded on 24th of April, 2026.