Rates entered the week on a bearish note as headlines over the weekend initially pointed to a potential re-escalation of the conflict. This was against the backdrop of markets having already become more worried about energy price pressures morphing into something more than just a short-lived inflationary episode.
The market started with three European Central Bank hikes fully priced by year-end, and the market was also leaning towards the Fed delivering a hike before the year is out. Geopolitical headlines remain the main driver of day-to-day volatility and direction, and initially, the news of the US temporarily lifting sanctions on Iranian oil exports turned markets around again – only to be denied later. Some relief came with Trump calling off strikes on Iran planned for Tuesday at the request of Gulf states.
This has allowed aggressive central bank pricing to ease somewhat. But especially concerning the Fed, there is no reversal to the shift that has taken place over the past week, where the market has swung to a clear hiking bias. Long-end yields also remain elevated with the 10y US Treasury clearly above 4.5% and the Bund yield above 3.1%. The latest conflicting news only confirmed that a quick solution still seems elusive.
Over the past week already, longer-term inflation swaps have also crept higher again as markets grapple with a potentially more prolonged inflationary impact. If we look at the EUR 5y5y swaps now at 2.19%, that is still less than 10bp above the average since summer 2024, though. Optimists might contend that this still points to very contained long-term inflation worries. The pessimistic view is that this implies things can still get worse from here. And we tend to agree with the latter, at least for the near-term risk to rates, after seeing how hard it has been to reach a solution to the Middle East conflict that brings down energy prices meaningfully and lastingly.