MOU-nting inflation concerns

Global Macro and Geopolitics

• Geopolitical tensions (Iran war context) drove global rates higher and caused a modest bear flattening of curves.
• Euro and UK rate markets exhibited higher volatility than US markets, driven by long positioning in the front end and sensitivity to oil price moves.
• ECB and BOE are viewed as central banks most responsive to inflation risks, leading to quicker market adjustments in their pricing relative to the Fed.
• Euro area 30-year OATs reached their highest level since 2008, indicating strong demand for long-dated government bonds.
• European life insurers added the most debt securities to their portfolios in Q1, the highest quarterly total in nine years, alongside strong pension fund buying.
• Bank of America (BofA) Global Rate Strategy anticipates this demand for long-dated debt will act as a backstop for European yields.
• Current market pricing suggests a 40 basis point increase for the ECB, though the strategist views an additional hike in September as the likely ceiling.
• For the Bank of England (BOE), the baseline forecast assumes no hikes with a potential cut by end-2027, unless oil rallies further, increasing the risk of a late-year hike.
• Clients are increasingly questioning whether geopolitical escalation will challenge summer carry trades, specifically long-end forward steepeners and periphery spreads.
• Political focus has shifted to France regarding upcoming elections, a new presidential candidacy by Marine Le Pen, and the government's difficulty meeting the 5% deficit target.
• Market participants are analyzing whether current geopolitical tensions will disrupt typical July seasonality patterns, which usually feature bond rallies and forward real rate increases.

US Inflation and CPI Forecast

• BofA expects June headline CPI to fall by 0.1% month-over-month (m/m), driven by a 10% decline in non-seasonally adjusted gasoline prices.
• Core CPI is forecast to rise 0.3% m/m (unrounded: 0.28%), reflecting "World Cup effects" on lodging, airfares, car rentals, and sporting events.
• World Cup-related demand is expected to provide a temporary inflationary impulse that should fade in subsequent months.
• Core services ex-housing inflation remains sticky, with motor vehicle insurance drag expected to diminish compared to the prior month.
• BofA forecasts core PCE to average 22 basis points in the second half of the year, which remains well above the 17 basis points required to hit a 2% run rate.
• Approximately 80 basis points of inflation can be attributed to temporary factors (World Cup, tariffs, oil pass-throughs), yet core inflation would still stand at 2.6%.
• Internal BofA credit card and hotel industry data support the view of increased demand and pricing power in the World Cup host cities.
• The risk profile to the BofA CPI forecast leans to the downside relative to current market pricing, though the firm remains at the high end of consensus.
• The Fed's focus remains on the "core PCE translation," with a projected 0.29% increase in core PCE for June, leaving year-over-year rates at 3.4%.

Fed Policy and Rate Outlook

• BofA maintains a forecast of three rate hikes this year, countering market complacency regarding the Fed's willingness to hike.
• Market participants are questioning how much inflation the Fed can "look through" as temporary versus structural.
• Recent FOMC minutes indicate that if inflation does not improve toward the 2% target soon, raising rates may be appropriate.
• Nine of 18 FOMC participants currently see a hike as appropriate, shifting the committee from a cutting bias to a hold/hike bias.
• Current financial conditions are viewed as "easy" by more FOMC participants than those who view them as restrictive enough.
• Historical data suggests the Fed rarely surprises the market on the hawkish side two weeks before a meeting; a July hike would likely require market pricing to reach ~80% probability.
• BofA estimates a core PCE implication of roughly 0.35% is needed to shift July to a modal probability for a hike.
• Retail sales are forecast to be double street expectations (headline, ex-autos/gas, and core control group), supported by strong underlying wage and deposit data.
• Upcoming Humphrey Hawkins testimony from Fed Chair Powell is expected to be a focal point, though no specific forward guidance for July is anticipated.

Fed Governance and Strategy

• Chair Powell has appointed a leadership team for new Fed task forces, selecting "five-star economists" with varying views to enhance credibility.
• The new task forces are designed to re-evaluate Fed practices without foregone conclusions, aiming to shake up how the institution operates.
• The selection of diverse, high-credibility economists is expected to facilitate greater buy-in from the FOMC for any resulting policy changes.
• BofA advises clients to maintain an underweight bias across the yield curve, specifically in the front end, citing the risk of higher rates.