US and UK ban Russian oil imports. EU might be looking to issue bonds to finance massive spend-up on energy and defense. German bond rates surge, pushing up US Treasuries

The war in Ukraine remains the predominant driving force for markets. Speculation on a plan for the EU to jointly issue bonds saw German yields rocket higher, feeding through into US Treasury yields. Oil prices are higher as the UK and US adopt a Russian import embargo. The AUD and CAD have underperformed against some turmoil in commodity markets. The NZD has been less affected, after domestic rates surged following a domestic trading bank calling for 100bps of hikes by May.

The US and UK are set to ban imports of Russian oil and oil products while the US will also ban Russian LNG and coal. For the UK, imports, will be phased out by the end of this year, allowing some time to see replacement markets. Options to end Russian natural gas will also be explored. The rest of Europe is much more reliant on Russian imports and there is no word on whether other countries will join the embargo. Chancellor Scholz has already made his view clear that Germany wouldn’t join any Russian oil or gas embargo, which would impose too big a cost on German energy consumers. Brent crude has increased overnight, and currently trades up 3% for the day at USD127 per barrel.

Other commodity markets remain in turmoil. The LME suspended trading in Nickel after a short squeeze drove prices above $100,000 yesterday. These transactions would be cancelled to reduce the fallout to traders caught on the wrong side of the trade and facing onerous margin calls. Other metals pared or erased gains following the LME’s announcement and other commodities are taking a breather.  After a massive upward run, wheat prices are down over 6%, while corn and copper prices are slightly weaker. Gold prices continue to be well supported on the safe-haven trade, reached as high as USD2070 per ounce, before paring gains.

Bloomberg reported that the EU is discussing a plan to jointly issue bonds on a potentially massive scale to finance energy and defence spending and this might be presented at the EU leaders’ summit that begins tomorrow. There are some hurdles to clear, including unanimous approval by the member countries, but there is recent form, with the €1.8T EU recovery fund launched last year in response to the pandemic. After the report, peripheral spreads to Germany narrowed significantly, with Germany’s 10-year rate up 13bps for the day against no change in Italy’s 10-year rate.

Within the last hour, President Zelensky said that he is no longer pressing for NATO membership for Ukraine and that he was open to compromise on the status of the two breakaway pro-Russian territories in Eastern Ukraine. This would satisfy two of the four conditions we mentioned in yesterday’s report that President Putin said could end the war. Reports of this news saw a positive turnaround in the euro and S&P500.

The Euro Stoxx 600 fell by “only” 0.5% and, while the S&P500 was mainly lower throughout the morning session, as we go to print it is now up over 1% for the session. Still, markets remain precarious and the VIX index is barely lower at a still-high 35 level.

The surge in Germany’s 10-year rate spilled over into US Treasuries. The 10-year rate is near its highs for the day, up 9bps to 1.87%. Traders remain convinced that despite the risks to the global economic outlook from the war in Ukraine, the higher inflationary backdrop won’t push the Fed off-course for a series of rate hikes. Six hikes remain priced for this year and the 2-year rate is up 8bps to 1.63%.

In currency markets, trading in EUR was choppy, as it gained ground after reports of the plan for EU bonds for massive fiscal expansion, later pared that gain, before being revived after Zelensky’s comments. EUR is up 0.8% overnight to 1.0950 and NZD/EUR has fallen to 0.6230. The AUD and CAD have weakened after commodity prices came off the boil, even though oil remains well supported.  The AUD has fallen 0.6% overnight to 0.7280.

The NZD has been less affected by the commodities turmoil and is barely lower overnight at 0.6825, after finding some support around 0.68. Thus, NZD/AUD has pushed higher to 0.9370 after earlier making a run towards 0.94.

Providing some support for the NZD, ANZ bank changed its OCR call to predict back-to-back 50bps hikes by the RBNZ over the next two meetings, which drove a surge in domestic short rates. The 2-year swap rate closed 12bps higher to 2.90% and short-end NZGBs were hit as well, with the 2023 bond up 15bps. The second and third bills futures rose 16-17bps in yield terms. The longer end of the curve was less affected and driven by global forces, which saw 10-year swap up 6bps to 3.05% and the 10-year NZGB up 8bps to 2.80%.

ANZ seems to be putting more weight on the near-term lift in CPI inflation, to over 7%, than the demand destruction of higher oil prices and the massive squeeze on household disposable incomes. We note that NZ consumer confidence is already down to levels consistent with economic recession. The world growth outlook is also threatened by the war in Ukraine. If anything, we’ve seen the market pare back expectations for global policy tightening in response to the war in Ukraine, not ramp them higher. One thing for sure is that central banks are in a difficult spot, with the commodity price shock coming at a time when inflation pressures are already uncomfortably high.

In the day ahead, eyes will be on RBA Governor Lowe’s speech on economic developments. China inflation data are also released, while the overnight economic calendar remains light.