The Confluence of Rising Oil Prices and a Slowing Global Economy Triggers Rates Spark

Up until now, core bonds have not been affected by the increase in oil prices. This indicates that concerns about global growth are more important than the worry of experiencing another cycle of inflation. At the very least, this means that there will likely be continued instability in interest rates and that the long-term yields will not decrease significantly.

The recent announcement of a production cut by OPEC+ could disrupt our prediction of lower rates this week. Our team of experts had to revise their projection of oil prices, with predictions that Brent crude will reach an average of $101 per barrel in the second half of 2023. However, the bond markets have not reacted much to this development. Meanwhile, the economic growth expectations are decreasing quickly, particularly in the United States because of the banking crisis in some regions. This has helped to prevent the energy market's impact from spreading to the rates market.

Raising the cost of oil may not necessarily bring about continuous inflationary stress.

The idea that external demand has decreased was reinforced by China's PMIs showing a decline. This could lead to fiscal support, according to our expert on China's economy. Furthermore, it's not just China as the US ISM manufacturing report indicates that higher oil prices may not necessarily result in lasting inflationary pressure. The new orders component specifically resulted in rates declining after an initial jump due to oil prices.

The current situation is still in the beginning stages, and predictions of increased oil prices by those we work with means that the rates market could potentially face higher risks. According to our predictions, the decrease in economic activity has progressed enough that the market should be mindful of the potential negative impact it may have on an already struggling economy. However, there is a worrisome option to consider: If growth does not slow down, central banks may become increasingly concerned and decide that further tightening is necessary.

The idea that rates will stabilize for the rest of the year is based on the belief that rates will also decrease. However, even if this prediction is accurate, there may not be a significant decrease in volatility. On a large-scale level, high volatility is a result of the many potential scenarios, ranging from a recession with reduced inflation to an economic rebound with higher inflation. Currently, the data supports the idea of a disinflationary recession, but unforeseeable events in 2023 have demonstrated that economic reports can be unstable. Furthermore, both of these extreme scenarios could potentially occur, but not at the same time, and in sequence.

The financial markets are anxious about banks maintaining a tough stance despite an economic downturn.

Even if the economy experiences a recession and a decrease in inflation, it doesn't mean that inflation won't return. Demographics, decarbonisation, and deglobalisation- the 'three Ds' that economists often refer to- suggest that investors may have a legitimate reason to fear above-target inflation if there is a subsequent recovery. As a result, we believe that long-dated rates will not drop significantly in this cycle, as more dovish central banks will result in a higher inflation premium. Although we anticipate that 10-year Treasury yields will decrease to 3% this year, we don't believe that lower levels can be sustained for long. The same is true for Bund yields falling below 2%.

In simpler terms, if central banks become less strict with their regulations, then there will be an increase in the steepness of yields curves. This week's market trends indicate that people are worried about the opposite happening - central banks sticking to their strict policies during an economic downturn. Frightful reactions from people like James Bullard from the Fed and Robert Holzmann from the European Central Bank yesterday likely added to these fears.

During the day in Europe, the consumer survey from the ECB will be closely watched, especially when it comes to people's expectations of inflation. The PPI will also be examined to see if there are any indications that inflation is starting to decrease.

The banks have been authorized by Italy to sell an 8-year green bond, which will increase the amount of scheduled auctions from other countries such as Austria (3-year/10-year), Germany (bonds linked to inflation), and the UK (16-year).

The US has recently shared the Jobs Opening report, which has garnered attention from individuals. While the primary figures seem strong, many people have noted the drop in 'quits rate' which might indicate a slowdown in employment opportunities. This will also contribute to the factory and durable goods orders.

People will be paying close attention to the speech by Chief Economist Huw Pill in the afternoon to see if there are any indications that the Bank of England is approaching the conclusion of its cycle of interest rate increases.