One of the most dangerous scenarios in global macroeconomics, and one that central banks fear most, is currently unfolding in bond markets. Breaking it down step by step and in its simplest form, the picture that emerges clearly reveals the predicament the system is in. The continued rise in oil prices is driving up production, logistics, and all energy costs, directly fueling global inflation. Inflation means the erosion of the purchasing power of money. In this environment, long-term (10 and 30-year) bonds offering fixed returns begin to cause real losses for investors. Smart investors, wanting to protect their money, quickly sell their long-term bonds. It's a fundamental rule of finance: as bonds are sold off, their price falls, and bond interest rates (i.e., borrowing costs) skyrocket.

Japan's announcement of a new fiscal package was the first signal that a massive burden of debt and liquidity would be placed on the market. This situation quickly spread. The hardest hit were energy importers, i.e., countries that buy oil from abroad using dollars. As oil prices rise, the bonds of these countries, which will have larger current account deficits and be forced to borrow more, have been ruthlessly sold off. Currently, the bond market is openly pressuring major central banks like the FED and the ECB, saying, "Inflation is exploding, aggressively raise interest rates and stop it!" However, central banks are constrained. If they raise interest rates enough to completely stifle inflation, they will completely lock down the economy and cause a severe recession. The market knows very well that central banks will eventually give up on raising interest rates due to this fear of recession.

This is precisely where the riskiest breaking point in financial history begins. Under normal circumstances, when a central bank raises interest rates, short-term (2-year) bond yields rise rapidly. However, in this scenario, the situation is completely different:

Short Term: Investors anticipate that the central bank will not be able to raise interest rates too much in the short term due to fear of recession, and short-term interest rates remain relatively calm.
Long Term: Knowing that inflation will spiral out of control in the long run because interest rates cannot be raised sufficiently, investors are rapidly selling long-term (10 and 30-year) bonds, causing long-term interest rates to jump. With long-term interest rates rising much faster than short-term rates, the bond yield curve is steepening. In financial literature, we call this Bear Steeping; it is the clearest evidence that inflationary expectations for the future are spiraling out of control.

A central bank's greatest power is not the money it prints, but the confidence it instills in the market. However, this situation shows that the market has lost confidence in central banks. The market is clearly telling central banks: "No matter what you say, we know you will back down due to your fear of recession and that you cannot control this inflation, so we are throwing away your long-term bonds." In short, we are on the verge of a very risky macroeconomic crisis where central banks are beginning to lose control, the risk of stagflation (high inflation + economic recession) is on the table, and long-term borrowing costs are spiraling out of control.