News coming out of the Middle East still seems to be mostly bad. US equities are weaker, US rates are higher and the NZD has fallen. Oil price rising

Following yesterday’s short-lived recovery in risk assets, markets have traded with a more cautious tone, as the news coming out of the Middle East still seems to be mostly bad.  US equities are weaker, US rates are higher and the NZD has fallen below 0.58.  Brent crude is trading at its high for the day around USD105 per barrel.

Yesterday afternoon, the WSJ reported that US allies in the Persian Gulf are inching toward joining the fight against Iran, getting tougher following persistent attacks that have disrupted their economies.  This signals a further potential escalation of the war in the Middle East. Other media outlets have since published reports in a similar vain.

Within the past hour the WSJ reported the Pentagon is planning to deploy a brigade combat team from the Army’s elite 82^nd Airborne Division to the Middle East – made up of roughly 3,000 soldiers that can be deployed within 24 hours, a possible precursor to “boots on the ground” in Iran.  This triggered a negative market reaction, even though it was previously suggested by Fox News and the NY Times.

Yesterday, Iran’s deputy speaker of Parliament ruled out negotiating with the US saying, “we will neither return the Strait of Hormuz to its previous state, nor will we negotiate with someone who is a liar and in whom there is no sign of honour, humanity, or conscience”.

Behind the scenes, many countries are getting involved, attempting diplomatic efforts to negotiate with the US and Iran to end the war. However, overnight the NY Times reported Saudi Arabia’s Crown Prince bin Salman has been pushing Trump to continue the war against Iran, saying that he must press toward the destruction of Iran’s hard-line government.  Saudi officials reject the idea that the crown prince has pushed to prolong the war.

Overnight, Israel’s Defense Minister said the campaign would continue at “full intensity”, as Iran continues to target Israeli cities.

Iran is still very much in control of the Strait of Hormuz, closing it to almost everyone and charging a $2m fee on a case-by-case basis to access to the strait, something it is looking to do on a more permanent basis.

Shell’s CEO said the world’s supply of fuel is tightening in South Asia and will soon get squeezed in Northeast Asia, with Europe set to begin seeing shortfalls in April due to the Iran war. 

Needless to say, the net balance of news around the Middle East continues to be bad, and yesterday’s rally in risk assets, following Trump’s postponement for five days of obliterating Iranian infrastructure, was a short-lived affair.

US equities are down ½% in early afternoon trading while the Euro Stoxx 600 index closed up 0.4%, ahead of the noted WSJ report on troops. The US 10-year rate is 4.41%, up 7bps for the day, or 3bps from the NZ close. Upward pressure returned to European rates, with more ECB GC members not afraid to offer hawkish commentary.  Croatia’s Vujcic said the ECB’s mandate is very clear and the central bank must be very agile and vigilant to keep inflation in check.

In currency markets, the NZD has underperformed on weaker risk sentiment, falling just below 0.58 on that WSJ news report.  The AUD has fallen to 0.6940, with NZD/AUD at 0.8350.  Other NZD cross movements are all modestly weaker overnight.

The market continues to pay only lip services to the economic data flow, with much of it pre-dating the conflict.  The flash readings for European and US PMI data for March consistently showed higher than expected readings for manufacturing, but lower than expected readings for services, leaving composite indices on the weaker side. Not surprisingly, inflation indicators were higher on the back on surging oil prices.

In domestic news, RBNZ Governor Breman’s message from her well-anticipated speech yesterday came across as a typical central bank response to a supply shock – look through the first-round inflation effects and react to second round effects. This gave the impression of not responding quickly with rate hikes but potentially needing a more aggressive response later. 

Her speech slightly added to the downside pressure to rates already emanating from global forces. NZGBs fell 3-6bps across the curve, with a steepening bias.  This was an underperformance relative to the swap market, where rates were 8-10bps across the curve. Some 10bps was shaved off OIS pricing for the May meeting, leaving it priced at about an even bet for a rate hike.  The first full rate hike is priced by July, with the market taking a view that mounting inflation pressure will force the RBNZ’s hand by the second half of the year.

In the day ahead, RBNZ’s Chief Economist Conway speaks on cost-of-living pressures as well as giving a brief update on the economy.  This is ahead of monthly CPI data for Australia and the UK.

Jason Wong is the senior Markets Strategist at BNZ Markets.