US Treasury yeilds to move higher?

More important than the timing of Fed's first rate increase is obviously the trajectory of future hikes. For this reason, some rightly argue that the timing of the second hike is actually more important than the first, because that will give us more information about the likely pace of tightening. 

The Fed will favour gradualism over aggression when raising rates, moving in small steps and with much caution to avoid undermining the economic recovery. This would likely have a calming effect on financial markets and could even lead to improving market conditions.

However, the Fed exit could be somewhat rockier down the road and it remains a concern. In particular, signs of markedly stronger inflation pressures could trigger a significant shift upwards in market expectations for futures rates with increasing concerns that the Fed is falling behind the curve.

This would likely imply a spike in Treasury yields, major adjustments in stock, credit and commodity markets and a much stronger USD and would exacerbate problems for vulnerable Emerging Markets, particularly those with large external financing needs and/or large debt burdens in foreign currency.

"Sky-high inflation is definetely not foreseen, but considering how low current market-implied inflation expectations are, it doesn't take much of a move there to send Treasury yields significantly higher", says Nordea Bank.

The recent acceleration in wage growth in the UK is a reminder of how fast inflation dynamics suddenly can change in economies operating close to full employment. In the UK economic recovery, stronger wage growth was also the long missing ingredient. 

However, over the past six to nine months wage growth has suddenly picked up, and regular pay in the private sector is currently rising at a 3½% annual rate, twice the pace seen in 2014 (see chart).

A shift in market expectations driven by much higher inflation expectations and/or a misreading of the Fed's intentions, rather than by a stronger growth outlook, would be much more difficult for the economy and financial markets to digest. The risk of severe market disruptions is exacerbated by the current lack of liquidity in global bond markets.