The latest US strikes on Iran in reaction to the attacks on ships in the Strait of Hormuz have sent oil prices higher, with Brent topping US$76/bbl. The feed-through to rates via front-end pricing is clear, and markets, for instance, are back to more than fully pricing another hike from the ECB before the end of the year.
But real rates have been a driving force of global rates over the past weeks and are likely to keep volatility elevated going forward. Historically, we see that global 2s10s swap curves in real terms correlate tightly, but more recently we have observed significant divergences. Global risk premia tend to move in sync and the figure below highlights the strong co-integration of term spreads of developed markets. Over time, the 2s10s curves seem to converge to similar values, which is consistent with the idea of converging risk premia.
Before the start of the Iran conflict, the term spread seemed to be stabilising around 50bp for USD, EUR and GBP rates. But in recent weeks the USD 2s10s has almost fully flattened in real space, while the sterling curve is a steep 90bp. For both currencies, we think markets are positioned as too hawkish, and thus we see downside potential for 2y real rates. A front-end repricing lower would help steepen the USD 2s10s without the 10y having to do much. In contrast, the already steep GBP curve means that 10y sterling rates should have more room to follow lower in case of a front-end repricing.