Wall Street closes at a record for the first time since end of January
The front end of the EUR curve is sticking to a very stable linear relationship with oil prices, but the back-end dynamics are more complex. While higher oil prices have bear flattened the curve at an increasing pace, the narrative of a longer supply disruption has upset that dynamic as of late
Longer EUR Rates Cannot Keep Up if Oil Pushes Much Higher
Hopes of a near-term resolution to the Middle East conflict are fading again, while growth concerns are still intensifying. Brent oil pricing well above $100 per barrel is too high for EUR rates markets to find comfort. The very front end of the swap curve has been sticking close to the script since the start of the war: a $10 rise implying almost an entire hike extra over the next 12 months. And with European Central Bank officials giving little pushback to the hawkish pricing, we don’t see why markets would deviate from this trading strategy.
But the story has been different further out the curve, where growth concerns have started to push downwards at higher oil prices. When we zoom into the 2s5s part of the curve, we see a non-linearity arising for higher oil prices. If the pattern were to hold, oil pushing beyond $120 poses the risk of a steep inversion. In this scenario, rate markets see steep ECB rate hikes followed up by a significant easing cycle on the back of deteriorating growth.
For Higher Oil Prices Longer Rates Struggle Keeping Up with the Short End
Source: ING, Macrobond
However, another narrative is gaining traction as of late whereby energy disruptions will last much longer than initially feared. And ECB President Christine Lagarde has fuelled such concerns with her latest interview in The Economist. She remarked that risks from the war are being underestimated and that the ECB’s technical experts believe that damage already incurred to the infrastructure was enough to disrupt the energy supply for years rather than just months. Laying out the spectrum of possible responses just earlier this week, she said "large, sustained deviations call for forceful monetary policy action."
Oil prices pushed rates higher over the course of Thursday. The front end is back to pricing more than three ECB hikes this year. But this time, the curve out to the 10y wasn’t lagging behind anymore – 2y to 10y rates all ended the day 11bp higher.
Friday’s Events and Market View
The oil impact moves into focus with Spain the first eurozone country to release flash CPI data for March. The headline year-on-year rate is expected to jump to 3.6% from 2.3% in February. But the ECB will also be watching the underlying eurozone inflation, which had nudged higher in February to 2.4% YoY, and markets currently still expect it to dip back to 2.3% next week. For Spain, that core figure is expected to rise to 2.8% from 2.7% today, though.
The ECB will also be releasing its consumer survey of inflation expectations. While this is for February, markets see them nudging higher on both the 1y and 3y horizon.
In the US, the market will look at the final University of Michigan Consumer index for March, which should now cover more responses coming in during the turmoil.
Central bank speakers will also remain key. From the ECB, Isabel Schnabel is expected to speak again. From the Fed, Tom Barkin, Mary Daly and Anna Paulson are slated for the day.
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