Bond Report: Treasury yields extend drop, with 10-year rate below 1.8%, as investors monitor Russian invasion of Ukraine

Shelling by Russian forces again pounded civilian targets in Kharkiv, Ukraine’s second-largest city, on Tuesday as satellite images showed a 40-mile convoy of Russian tanks and other military vehicles advancing on Kyiv, the capital.

The U.S. and other Western nations hit Russia with additional sanctions over the weekend and Monday, effectively removing more Russian banks from the SWIFT interbank messaging system and taking aim at the country’s central bank in a move that has seen hampering its ability to access its large stockpile of currency reserves. The ruble
USDRUB,
-0.78%
collapsed Monday, hitting an all-time low in a volatile trading session.

Read: Sanctions take aim at Russia’s economy: Here’s who is most exposed

Investors are weighing the implications of the invasion on the outlook for inflation and global growth, as well as how central banks, particularly the Federal Reserve, will respond. Commodity prices have surged in the wake of the invasion and sanctions, with Brent crude
BRN00,
+8.64%,
the global oil benchmark, trading above $104 a barrel early Tuesday.

But uncertainty about the economic outlook has prompted traders to less aggressively price in big rate increases by the Federal Reserve and other major central banks. Rate futures were pricing in a roughly 6% chance the Fed would hike interest rates by a half-point this month. That’s down from 41% a week ago, according to probabilities derived in the CME FedWatch tool. The market is now pricing in a 94% chance of a quarter-point increase.

In data releases, the final reading of IHS Markit’s manufacturing purchasing managers index came in at 57.3 in February versus an initial 57.5 reading. The Institute for Supply Management’s manufacturing index rose to 58.6% in February from 57.6% previously and the prices paid index slipped to 75.6% from 76.1%.

President Joe Biden will deliver his State of the Union address on Tuesday night.

See: Russia-Ukraine war, surging inflation, rising rates: Here’s how some see the state of stock market as Biden readies State of the Union.

Employment data will also roll in this week, culminating in the Friday release of the official February jobs report. Federal Reserve Chairman Jerome Powell is slated to testify before a House panel on Wednesday and a Senate committee on Thursday.

What are analysts saying?

“The dramatic adjustment to interest rate expectations continues. The market has now nearly fully rejected a 50 [basis point] hike” by the Fed, the Bank of England and the Bank of Canada, said Marc Chandler, chief market strategist at Bannockburn Global Forex, in a note.

“Uncertainty tends to be a drag on economic activity, as companies opt to delay decisions rather risk making a strategic mistake,” while rising energy prices “are a double-edged sword,” said Steven Ricchiuto, chief U.S. economist at Mizuho Securities, in a note.

Rising energy prices are clearly inflationary, but “the adverse effect on household purchasing power tends to be a drag unless there is a direct link between prices and wages like the one that existed in the 1960s and 1970s,” he said. Geopolitical uncertainty and rising energy prices “add to our more cautious outlook on the economy (and the Fed) than consensus. Specifically, we see the economy slowing from 4% in the current quarter to just 2%-2.25% by year-end and, as a result, we believe the market is overestimating the required Fed policy response, principally because not enough consideration is being given to the fiscal policy drag being imposed on the economy.”