Higher oil prices meet slowing global growth
The cut in OPEC+ production announced over the weekend is a wild card that could backfire our call for lower interest rates this week. Our fellow commodity strategists have had to revise their oil price forecast upwards as a result, with Bretn now facing an average of $101/bbl for the second half of 2023, but bond markets have so far shrugged. Rapidly declining growth expectations, especially in the USA as a result of the regional banking crisis, are helping to dampen the contagion from the energy markets to the interest rate markets.
Higher oil prices may not fully translate into persistent inflationary pressures
This view was supported by the fall in Chinese purchasing managers’ indices and the negative signal for foreign demand. However, our China economist notes a silver lining as the report increases the likelihood of fiscal support. China wasn’t the only part of the world to suggest that higher oil prices may not fully translate into persistent inflationary pressures. The slowdown in US ISM manufacturing, particularly the forward looking component for new orders, helped rates more than recover from their oil-induced jump.
It’s early days and higher oil forecasts from our peers are clearly raising the stakes for rates markets. In our base case, the slowdown in economic activity is sufficiently advanced for markets to at least consider the adverse impact it could have on already faltering growth. However, the alternative scenario is daunting. If growth doesn’t slow, already nervous central banks could conclude that more tightening is indeed needed.
Higher oil prices would raise the stakes for interest rate markets and prevent implied volatility from falling
Source: Refinitiv, ING
The stakes for the markets are high and swaptions reflect the wide range of outcomes
The argument for lower interest rate volatility for the remainder of this year is based on the hope that rates will also converge lower. While this view, which is our view, proves correct, lower interest rates may not result in much lower volatility. At the macro level, higher volatility simply reflects the wide range of possible scenarios, from a disinflationary recession to an inflationary economic recovery. Data confirms the earlier scenario for now, but 2023 proved that economic releases can be volatile. Also, both extremes could turn out to be right, not simultaneously but sequentially.
Markets are nervous as banks remain hawkish in the face of a recession
Even a recession and a fall in inflation do not necessarily mean the end of inflation fears. The “three Ds” (demographics, decarbonization, and deglobalization) often cited by economists mean that investors have legitimate concerns that a subsequent recovery could prompt a return of above-target inflation. This is one of the main reasons we doubt long-term interest rates will fall sharply this cycle, as more dovish central banks would result in a higher inflation premium. This means that while we believe 10-year government bond yields will fall to 3% this year, we doubt that lower levels can be sustained for long. The same applies to Bund yields that fall below 2%.
The corollary is that the more dovish central banks become, the steeper the yield curves will be. Price action so far this week suggests markets are fearing the opposite: central banks remain hawkish in the face of a recession. Hawkish comments from the likes of the Fed’s James Bullard and the European Central Bank’s Robert Holzmann yesterday likely fueled those fears.
A surge in inflation swaps prevented short-term interest rates from falling in tandem with long-term ones
Source: Refinitiv, ING
Today’s events and market overview
In the European hours, the ECB’s consumer survey is likely to be the key focus, particularly inflation expectations. The PPI is also scanned for signs of easing inflationary pressures.
In the bond offering, Italy has mandated banks to sell an 8-year green bond. This will come on top of scheduled auctions from Austria (3Y/10Y), Germany (inflation-linked bonds) and the UK (16Y).
US publications include the Job Opening report. Despite robust headlines, some have cited the falling quits rate as a sign of a slowing job market. This will be in addition to factory and consumable orders.
Chief Economist Huw Pill’s speech this afternoon will be closely watched as to whether the Bank of England is nearing the end of its growth cycle.
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