The US bond market is showing uncommon differentiation, inflation impact is seen as temporary pressure, the market still trusts the Federal Reserve.

On Tuesday, the US bond market saw a rare divergence, reflecting investors' markedly different views on short-term and long-term inflation prospects. The current market expects a significant increase in inflation over the next two years, while expectations for long-term inflation remain stable. This divergence indicates that investors generally believe that the inflation pressure brought about by the Iran conflict is more temporary and still have confidence in the Fed's ability to control inflation in the long term. This change is reflected in the inflation breakeven rates. Data shows that the two-year inflation expectation is significantly higher than the ten-year expectation. On Tuesday, the two-year breakeven inflation rate was around 3.3%, while the ten-year rate was around 2.36%, with a spread of close to 0.94 percentage points, three times the average level of the past five years and close to the high point during the inflation panic a year ago. Analysts point out that this pattern of "short-term inflation rising, long-term inflation anchored" highlights the market's rational judgment on the impact of the current conflict. Cameron Dawson, Chief Investment Officer of NewEdge Wealth, stated that there is a clear "gap between short-term and long-term inflation expectations" in the current market. Prior to the coronavirus outbreak, the situation was the opposite, with the market usually expecting long-term inflation to be higher than short-term inflation. Such structural differentiations are not common in history. Gina Martin Adams, Chief Market Strategist at HB Wealth, noted that the US is experiencing its second inflation panic in the past five years, with a similar scenario occurring during the Russia-Ukraine conflict, a frequency that is extremely rare since the high inflation period of the 1970s. In terms of market pricing, investors expect US inflation to approach 4% in the coming quarters. Padhraic Garvey, Head of Americas Research at ING, believes that this expectation reflects a significant boost in short-term inflation due to rising energy prices. Nevertheless, long-term inflation expectations remain stable, showing that market confidence in the Fed's policy framework remains intact. Data shows that since the outbreak of the Iran conflict, the ten-year inflation expectation has only slightly increased by about 0.10 percentage points, while the two-year expectation has risen significantly by nearly 0.48 percentage points. Analysts point out that if the market truly fears that the Fed may excessively cut interest rates due to policy pressure, leading to sustained high inflation, long-term inflation expectations are unlikely to remain as stable. However, there remains significant uncertainty in the short-term policy path. With the rise in inflation expectations, investors have all but abandoned expectations of a rate cut at the April Fed meeting. According to the CME Group's FedWatch tool, about 97.4% of market participants currently expect the Fed to keep rates unchanged, with only a few betting on a rate hike. At the same time, if high oil prices continue to suppress consumer spending and business hiring, leading to economic slowdown or even recession, the market still believes that there is room for rate cuts in the future. Analysts suggest that in this scenario, the Fed may be forced to return to a more accommodative policy.