Rates Spark: Euro Rates And The War

While some ECB officials have been trying to retain flexibility on the next policy move, it remains conditioned on Iran. The Bundesbank’s Nagel and Austria’s Kocher suggest a hike remains on the table unless there is a marked improvement, continuing to tie the front-end discount to the price of oil. Our view on the war standoff is unchanged – it's here.

Rates could fall slower than growing optimism suggests

Brent oil prices have been settling more clearly below the US$100/bbl threshold in anticipation of a deal that also reopens the Strait of Hormuz. However, our commodities strategists do not see that much room for further significant drops in the oil price even if the Strait were to reopen soon.

First off, one would need to assess the infrastructure damage incurred during the height of the conflict. More importantly, economies have been drawing heavily on reserves over the past months, which will need to be restocked. This implies higher-than-normal demand for now as supply lines reopen.

If oil prices have limited room to drop, that also means inflationary pressures will remain in place and not vanish all of a sudden. Greater certainty on the outlook may provide central banks with some leeway to look through the near-term rise in inflation prints that is still to come. However, communication is unlikely to shift to an outright dovish stance, as officials will want to assess how still‑elevated prices continue to filter through the broader economy.

For markets, this means an elevation of rates and central bank discounts that should only be pared more gradually. At least relative to what markets are liable to display amid a first euphoria around an emerging deal. And keep in mind, re-escalation risks are also not entirely off the table just yet.

Friday’s events and market view

The US jobs report on Friday might be one of the few data releases that can take the attention off the Middle East situation, even if only briefly. Expectations are for a payrolls increase of 65k, close to the 3m rolling average versus last month’s 178k. The unemployment rate is expected to stay at 4.3%. The other US release of note today is the preliminary University of Michigan consumer confidence index, which tends to move more closely – and inversely – with inflation expectations. The European morning will see industrial production data from Germany and Spain.

Away from the data, central bank speakers will have a chance to steer expectations as markets eye the possibility of a deal in the Middle East. From the ECB, Lagarde, de Guindos and Schnabel are scheduled to speak. From the BoE, Governor Bailey and Breeden will speak while the Fed only sees a scheduled speech from Cook – on tokenisation, though.

The gilts market will look at the results of Thursday's local elections that should become available throughout the day.

In ratings, Fitch has reviews of Cyprus, Greece and Slovakia on schedule. DBRS has Germany up for review.