Summary
Something had to give. A day after global stocks and other ‘risky assets’ rallied in the face of U.S.-Iran geopolitical escalation, the U.S. benchmark Treasury yield creeping back to the psychologically potent 3%, either investors would soon retreat or borrowing costs would. There was a clue in Wall Street’s solid close. The failure of the 10-year yield to sustain gains just 1 tick above 3% for long helped confirm a pause in Treasury selling. Of course, this cross-asset status is inherently unstable. The market’s reaction to ratcheting global risks combined with overbought oil looks out of kilter with sentiment just a week ago. Once giant oil shares are no longer doing the heavy lifting for equities, things could look much different.
On Thursday though, markets on both sides of the Atlantic were still rising in unison, if cautiously, following a similar tone among Asian counterparts, where the MSCI’s broadest Asia-Pacific gauge excluding Japan edged up 0.4% despite a shock election result in Malaysia.
There were also signs that the market expected a tightening crude oil demand/supply balance to support prices, regardless of the ultimate outcome of the U.S.’s exit from Iran nuclear deal. In the futures market, widening premium on nearer-dated contracts compared to those dated further forward is generally a sign of concern that supply is falling. The ‘December/December’ spread – the difference between contracts expiring at the end of the current year and those expiring in December a year ahead – was at the widest in five years on Thursday. The measure echoed the last time Iran was forced to cut oil exports. At that time, they Iranian oil output fell 40% to about 1.3 million barrels a day by late 2013, half Iran’s current output. It’s too early to predict what prices will do this time.
Either way, the rhetoric out Iran was defiant. Comments by top Tehran officials continued to corral the remaining four signatories to the original Iran deal, aiming to isolate the United States. Meanwhile, OPEC sources said Saudi Arabia was not prepared to act alone to fill any oil shortfall.
Elsewhere in OPEC, Venezuela’s cash-strapped funding situation took its own toll on supply. Additionally, Brent futures forward curve continues to show the market expects prices to drift to as low as $67/bbl. in two years, the curve is rallying in May next year. It projects prices well above $70/bbl. With Wednesday news that U.S. inventories fell last week, oil has delayed its inflection point for the near term. Brent remained supported on the $77 handle on Thursday, having set its latest 3½-year high at $78/bbl. earlier.
FX
Consolidation rather than retracement was the word for the dollar. The Dollar Index was perched topside of a significant long-term price of 92.95, a former support before the severe correction beginning in September 2017 and resistance in January. Global news flow supported the greenback.
EM currency and yield disruption continued with the introduction of another potential source of instability in Malaysia. Moody’s saw the country in 'unchartered waters' after the surprise return of controversial former prime minister Mahathir Mohamad to power via an opposition alliance. Forward contracts on Malaysia's Ringgit tumbled 2% whilst debt insurance costs soared. However, there was little sign that domestic market stress was spreading into nearby regions.
In Europe though, the single currency was subtly undermined at the periphery as the spread between the yield of Italian BTPs to bunds widened the most in six weeks. It followed progressing talks between leaders of the anti-immigration Northern League and anti-establishment Five Star. Neither party has the same Eurosceptic edge they used to, but Italy’s 10-year debt yield could draw for euro towards December’s $1.1718 low from $1.1873 at last check, after the euro scraped a new almost five-month low at 1.1821 on Wednesday.
With most London trading attention on the Bank of England’s policy and forecast update at midday, missed UK factory prices barely stirred sterling traded against the dollar. The pound continued to inch higher from Tuesday’s four-month lows below $1.35. The lack of a rate rise on Thursday is baked in. What’s in question is the extent of any downgrade of policymakers’ forecasts. The Bank could trim inflation forecasts further but keep a projection that inflation would be slightly above the 2% target in three years’ time. As such, a rate rise would still be required this year to reach that target over the "more conventional horizon" Carney envisaged in February.
The Bank’s annual growth target averaging 1.75% over the next three years could see a similar trim. The wild card is how voting (7-2 last time) will play out. Whilst chances are on the outside, the knowledge that tightening is off the cards could encourage additional dissenters to show their hands after Ian McCafferty and Michael Saunders became the first to vote for a hike in March as they were in 2017.
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