Wall Street closes at a record for the first time since end of January
Trump’s rhetoric does not offer markets a tangible solution. This will keep both oil prices up and risk aversion raised as we enter a long weekend. Despite pushback from the Bank of England, sterling rates continue to take a very hawkish stance compared to peers, which should start to weigh on the belly of the curve if materialised
Start of a Long Weekend Will Keep Markets on Edge
The hope was that US President Donald Trump would appease markets with concrete steps towards ending the war in the Middle East. Unfortunately, the rhetoric appeared largely unchanged, keeping markets on edge. Today is the last day before the start of a long weekend, with US markets closed on Friday; in Europe, Monday will also be a bank holiday. As such, we doubt oil can move materially lower, and risk sentiment should stay fragile.
In effect, that means the upward pressure on the front end of the curve will stay. The 5Y and 10Y points might face less upward pressure as growth concerns over the medium term intensify. Inflation markets continue to be positioned for a short-lived inflation spike, which then begs the question of how much easing central banks follow up with after their hiking cycle.
This will all depend on the resilience of the economy after tightening policy while facing higher energy costs. In the worst outcome, central banks might have to cut aggressively into accommodative territory to mitigate recession risks. Such a scenario helps explain why the belly of the curve can outperform in the current environment.
Markets are set on a hawkish Bank of England
Sterling rates are showing a higher sensitivity to oil prices than EUR and USD rates, and even dovish pushback from the Bank of England is achieving little. Our screen now shows almost 50bp of hikes being priced in for this year, which is a complete turnaround from the two cuts being priced in February. For every $10 increase in the oil price, GBP rates are adding 34bp of tightening over the next year.
This is just 25bp for euro rates and 18bp for dollar rates. Even BoE Governor Andrew Bailey didn’t meaningfully move the needle to a more dovish stance despite being very vocal that “markets are ahead of themselves”.
The hawkish reaction from markets is mainly a product of the hotter inflation outlook, reflected by a 2Y inflation swap of well above 4%. In comparison, this is just 2.7% for eurozone inflation. From a curve perspective, we would argue that a more aggressive hiking cycle would worsen the medium-term economic outlook more, helping the belly of the curve to outperform.
These dynamics are already pronounced in the GBP curve, which has seen the 2s5s10s move from around -8bp to -15bp. If we do get a BoE as hawkish as markets are pricing in, then we can expect the 5Y point to see more downward pressure.
GBP Rates Are Most Sensitive to Oil Price Moves
Thursday’s Events and Market Views
Markets will be closed on Friday, and this means investors will need to decide how much risk to take into the long weekend, which will also include a US payrolls report. But before that, we first have the Challenger jobs report and initial jobless claims on Thursday.
The focus is still on the Middle East conflict, which means macro data is still secondary in terms of market drivers. More interesting could be the various central bank speakers, including the ECB’s Francois Villeroy, discussing monetary policy in Paris.
In terms of supply, we have France with 9-Year, 10-Year and 22-Year OATs together with an 18-Year green OAT for a total of €12.5bn.
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