Rates Spark: Something Must Give

Whilst equities are still going strong, rates markets are not blind to the creep higher in oil prices. With Brent well above $100/bbl again, both the ECB and BoE could hike at least twice this year. Reaching $110 would push the 2Y EUR to 3% and the 2Y GBP above 4.4%. The US 10yr would top 4.5%. Equities are off script, but capable of changing the narrative.

Something must give. Perhaps President Trump's barometer of success?

President Trump's barometer of approval – the stock market – has been flashing 'nothing negative to see here' for the past few weeks. We can't say for sure, but it is quite likely that it has been a factor supporting the US stance to play hard ball. The US may have done that anyway, but risk asset comfort together with a mostly sub-$100/bbl oil price has absolutely helped. President Trump noted flippantly on CNBC earlier this week that he was surprised that equity markets had not collapsed by 20% or worse, and that the oil price had not hit $200/bbl (painting $90/bbl as a win). Understood that this is just talk; but still.

Ahead, a big risk is that something gives, and we go risk-off. Every day that the Strait of Hormuz remains closed heightens that risk. So far, we've had a mild dip from the highs in risk assets. But a large swoosh lower is the type of outcome that would get the President's attention. And if equities are indeed falling, bond yields are likely to rise, on a theory that inflation expectations come under renewed rising pressure. Beyond oil prices and energy prices generally, don't forget food prices (driven by higher fertiliser prices). Higher bond yields would certainly get the attention of the whisperer, Treasury Secretary Bessent.

Something has to give. Either we have a solution of sorts that reopens the Strait, or the markets force an agreement to reopen. The latter clearly presents the more uncomfortable path.

Watch oil creeping higher because rates are still following closely

Oil prices continue to creep higher and alongside global shorter-dated rates. The moves have become less pronounced, but markets are clearly adding a premium to oil prices every day the Strait of Hormuz stays closed. At some point, financial markets will not let the drift higher in energy prices and rates go unnoticed. But with the S&P 500 still hugging record highs, markets are still at ease to give the negotiations more time.

With Brent above $100/bbl again, both the European Central Bank and the Bank of England are expected to hike by more than 50bp this year. Even though the rise above $100 was less volatile this time, rates are still closely following the script since February. Extrapolating from this, oil rising back to $110 would push the 2Y EUR swap rate some 20bp higher to around 3.0% and the 2Y GBP swap would reach above 4.4%. With oil moving up by almost $10 over just a few days, these levels do not seem far out of reach.

Short rates are still closely following their script

Friday's events and market view

A relatively light day in terms of data. We do have the German Ifo survey outcomes from April. Consensus sees a mild deterioration, but given the Middle East turmoil, the numbers will be difficult to translate to an economic impact.

For issuance, Italy will auction a 2Y BTP for €2.25-2.5bn.