Rates Spark: The damage has been done

Articles Rates Spark: The damage has been done 18:42 Rates Spark Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download A slide lower in oil prices has helped rates dip, but we're not returning to pre-war yield levels. The US 10yr real yield is likely to remain elevated, and US inflation breakevens have little room to fall further. The ECB has already hiked once, and at least another hike is discounted.

We anticipate more oil price volatility as a big reserve rebuild kicks off Padhraic Garvey, CFA , Benjamin Schroeder and Michiel Tukker Lower oil prices help, but we still expect bond yields to remain elevated due to inflation Treasury yields to remain sticky to the upside, as real yields remain elevated The Iran deal gets signed physically on Friday. But already apparently 'electronically signed'. The proof will come from the Strait, and the beginnings of a reopening is all markets care about.

President Trump has promised this from Friday onwards. Reaction so far on the rates market has been predictably muted. Well before this deal, breakeven inflation rates had been falling.

They are now back to where they were before the war started, which is quite remarkable (US 10yr breakeven at 2.3%; a perfect score). US real yields are structurally higher by some 40bp since before the war, which, again, is quite remarkable. We doubt they collapse lower, which is why the 10yr yield will remain elevated.

It's down post the deal announcement, but not by much. The 10yr yield is holding in the 4.45% area, where it has tended to hover in recent weeks. The 10yr real yield is just above 2%, which is broadly a neutral valuation, one that we saw before the GFC / pandemic impacted years.

Barring a recession, it can hold in this area. We broadly move on now. The US/Iran discussions continue.

The Strait eases up. And the market discount for structurally negative inflation repercussions continues to ease. But note, we still have elevated inflation prints to deal with, as inflation is already elevated.

And there is another month or so of follow-through to come on this. It makes it tough to get overly bullish on bonds, at least not given what we know. Don't expect rates to return to when everything started Brent prices have now dropped from close to US$100/bbl down to almost US$80/bbl in the span of less than two weeks.

However, over the same time span, the market has already come to the conclusion that much of the damage has been done, and the overall reaction function of rates to the geopolitically driven oil prices has already settled at a higher level. That means, while oil is at its lowest point since early March, 10y EUR swap rates are still around 3%, a level that has marked a soft floor to the long end rate over the past few months. The European Central Bank has, of course, already created facts in the meantime by delivering a rate hike last week.

More importantly, official commentary even after the news of the deal over the weekend continues to lean hawkish, citing first signs of second-round effects and this being no time for complacency. The market is proving very reluctant to set aside its expectations of a second ECB rate hike, which remains more than fully priced by the end of the year. The market reaction has also been faster than realities on the ground, and it can be altered by the prospects of a deal.

A more durable repricing requires safe, predictable and insured shipping through the Strait of Hormuz. And demand could likely to be higher than usual as depleted reserves need to be replenished. Re-escalation risks are reduced, but not off the table.

For longer EUR rates at least, we also think that this is also only part of the story. The US narrative of macro resilience and the hawkish repricing that went in hand with it will also have had spillover effects. After all, it has been US real rates that have driven the leg higher, all the while (market-)inflation expectations have remained at very tolerable levels.

What hasn’t gone up in the first place with energy prices is unlikely to offer much relief as the latter has now come down. Tuesday’s events and market views Mostly second tier data on the agenda, likely to keep the focus on geopolitical developments. From Europe, we will have the outcomes from June’s ZEW business survey.

For Germany, consensus sees a slight improvement in the expectations component, but still stuck in negative territory. For US data we have the import price index. When excluding petroleum, import prices are expected to rise by some 0.5% month-on-month.

Housing starts data from May is expected to show a slight cooling from the previous month’s figure. In terms of ECB speakers, we have Chief Economist Lane and Sleijpen from the Dutch central bank. In primary markets, Germany will auction 5y bonds (€5bn) while the UK auctions 10y gilts (£4.25bn).

Later the US Treasury will auction 20y bonds (US$13bn). Rates Daily Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument.

Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Authors Padhraic Garvey, CFA Regional Head of Research, Americas Padhraic Garvey is the Regional Head of Research, Americas. He's based in New York. His brief spans both developed and emerging markets and he specialises in global rates and macro relative… Benjamin Schroeder Senior Rates Strategist Benjamin Schroeder is a senior rates strategist at ING in Amsterdam.

Before joining ING in 2016, he worked in fixed income research at Dresdner Kleinwort and Commerzbank in Frankfurt, Germany.… Michiel Tukker Senior UK & Eurozone Rates Strategist Michiel Tukker is a Senior UK & Eurozone Rates Strategist based in London. Before ING, he worked as a quantitative economist for the Dutch central bank, at BlackRock in its Financial Markets… In this article Treasury yields to remain sticky to the upside, as real yields remain elevated Don't expect rates to return to when everything started Tuesday’s events and market views