Investors are all set for a highly bumpy ride

An almost eerie period of low financial market volatility seems to be ending as exceptional US economic expansion reignites dollar and bond yields worldwide while geopolitics worsens, emerging markets struggle and stocks wobble.

There are good reasons to cheer the biggest economy ’ s resilience, but the pivotal role of the dollar and US treasury borrowing benchmarks mean continued US divergence from the rest spells financial turbulence ahead. With US first-quarter growth now pencilled in close to 3%, retail sales still roaring through March and inflation and inflation expectations stuck above 3%, the US Fed will find it hard to cut interest rates in 2024 while other major economies feel pressured to ease soon.

After similar soundings from his colleagues over the past week, US Fed chair Jerome Powell set the tone late on Tuesday by bemoaning lack of progress on disinflation as the US economy stays strong, and said restrictive policy needs more time to work.

While the IMF nudged up its 2024 world growth forecast by 0.3 percentage point to 3.2% in the past six months, it dramatically raised its US growth call 1.2 points to 2.7%. Outlooks for the rest of the G7 were downgraded in that time. Even projected growth in emerging markets at large was lifted only 0.2 point.

Add investor anxiety over the Middle East and US election uncertainty a little more than six months away and you have a potential tinder box in markets.

With the dollar’s long-presumed decline on the back of Fed rate cuts now cast aside and the greenback’s main traded index surging to 2024 highs, previously serene gauges of implied currency volatility ahead reared up this week.

The CVIX index jumped from two-year lows last month to its highest level in two months this week as the Fed calculus shifted, the European Central Bank appeared to double down on a June rate cut and Japan’s yen plummeted to 34-year lows — seeding competitive pressures across Asia’s exporting nations.

Pressure on China to lean on exports again, as domestic demand recovery continues to be dogged by the property bust, has opened up cracks in the yuan too. Bond markets have already been coping with elevated volatility since the inflation and interest rate spikes of 2022. But hopes for a return to more “normal” treasury market swings have also been bamboozled by the US and Fed rethink.

The MOVE index of implied treasury volatility sank to its long-term average last month or less than half the levels seen during banking disturbances last year. But it too leapt by a third in April to hit its highest level since the year began.

US consumer price inflation misses since the turn of the year and the shift in Fed rhetoric have spurred 10-year treasury yields back up to 4.70% for the first time since the October bond blowout in 2023. Long-term market inflation expectations, captured by the five-year, fiveyear forward inflation-linked swap, jumped a quarter of a percentage point to almost sixmonth highs of 2.75%, far above the Fed’s 2% target.

Long-duration bonds have been battered and exchangetrade funds tracking 20- and 30-year treasuries are now down more than 10% for the year to date — having lost a whopping nearly 40% in a little over two years.

And the scale of the withdrawal from bonds was evident in the latest global fund manager survey from Bank of America.

The poll showed a huge 20percentage-point drop in overall allocations to bonds this month

— the biggest monthly fall since 2003 and leaving asset managers registering a net underweight position of 14%. The share of funds expecting bond yields to fall over the next 12 months has been almost halved to just 38% since the beginning of 2024. Despite the more dovish take on interest rates of central banks in Europe and elsewhere — amid softer growth and inflation readouts there — the treasury yield resurgence has still hauled up sovereign yields everywhere in its slipstream. The heft of treasuries in global bond portfolios is at least partly to blame.

But as all debt markets are repricing again to reflect the absence of a global recession on the medium-term horizon — and the IMF’s latest forecasts on Tuesday showed modest 3%plus world growth rates right out through 2029 — all long-term debt is forced to find a new level. Though more speculative corporate “junk” bond prices were hit too, the absence of a recessionary red flag means the borrowing premium on US junk yields over treasuries remains under wraps at its smallest in two years. But for developing economies with heavy borrowing in dollars, the combination of climbing treasury yields and renewed dollar strength spells trouble again.

For pricey equity markets that should on balance benefit from the pumped-up growth outlook, the more turbulent rates world is taking its toll.

Add to that the restive political backdrops and the prospect of weeks or months of nervy weekends over the Israel-Iran standoff, and the “risk-off” mood has stirred volatility there too.

The “fear index” of S&P 500 implied volatility had remained depressed during a bumper first quarter for US stocks — but it has reawakened too this week and hit its highest level in more than five months. Touching its 35year average just under 20, the index ended the week below that in all but two weeks since the regional bank fracas last year

— and those two weeks were during the bond ructions of October.

Volatility uncorked across the world? It may be a very bumpy ride for investors through the summer.