The reaction in the bond market to the US-Iran conflict is something that should warrant more attention. While traders are focused on the risk side of things and safety flows, it’d be easy to miss that Treasury yields have actually gone up since the end of last week. 10-year yields are up another 5 bps today to 4.107%. That is well over 15 bps higher from where we finished up in February.
In a time when traders have to balance out seeking safety assets and pricing in higher inflation expectations, the latter looks to be taking over in a relatively strong manner. That as we see oil prices spike higher again with WTI crude oil now up over 6% to $75.65, its highest level since June last year.
And if you look at major central bank pricing, the market reaction that we’re seeing is starting to make more sense now. The appetite for rate cuts is diminishing and the narrative for some major central banks is totally shifting in favour of rate hikes instead.
Looking at Fed fund futures, the odds of a July rate cut have dropped further to just ~65% now. And by year-end, traders are now just pricing in ~43 bps of rate cuts by the Fed. That as opposed to the ~59 bps priced in at the end of last week.
Alongside the resurgence of the petrodollar, this is also another strong shift in the winds that is keeping the dollar more bid this week.
Meanwhile earlier today, traders have also even gone as far as to price in ~25% odds of the ECB raising interest rates at the end of the year. And those odds have increased further to near 40% after the hotter-than-expected euro area inflation numbers here.
At the end of last week, traders were pricing in no movement whatsoever by the ECB all throughout the year. And if anything, policymakers were still trying to play down chances of a rate cut. Now, the script has flipped and we have to weigh up rate hikes instead by the central bank.
And just like the Fed, the BOE has also seen rate cut odds diminish significantly. Traders were pricing in ~52 bps of rate cuts by year-end on Friday but are now just seeing ~24 bps of rate cuts by year-end.
Putting the pieces together, it looks like inflation is back on the menu and that is starting to cause a material shift to the outlook for major central banks. And that could matter much more than any temporary risk reaction that we’re seeing to the US-Iran conflict in the meantime.
This article was written by Justin Low at investinglive.com.
