Asset markets recover from initial weakness after Trump threatened to blockade the Strait of Hormuz. Brent crude prices remain higher but well-below the recent peak. USD and yields fall

Asset markets started the week under pressure after President Trump threatened to blockade the Strait of Hormuz in response to the collapse in talks with Iran. S&P futures opened more than 1% lower yesterday, but risk appetite has recovered despite oil prices remaining higher than Friday’s level. US equities rose to session highs after President Donald Trump said Iran still wanted to make a deal despite stalled peace talks. The S&P is up close to 0.5% and is currently near its highest level since early March. Meanwhile, Treasuries recovered from an initial sell-off alongside a pullback in the US dollar.

Brent crude reached a high near US$104 per barrel yesterday morning and has since retraced toward $99 but remains $5 higher than the end of last week. The US began blockading vessels transiting to and from Iranian ports, heightening supply risks as the move could cut off Iranian shipments. The policy has prompted Tehran to threaten retaliation against vessels and ports. The US military said the blockade will cover Iran’s entire coastline, with ships subject to interception, diversion or capture.

US Treasuries erased early losses as oil prices pulled back from the day’s highs. Yields on US 10-year notes opened higher in Asia and rose to 4.36% before steadily retracing. Current levels near 4.31% are little changed from the end of last week, despite oil prices settling materially higher. Ten-year gilt and bund yields both closed around 4bp higher. Japan’s 10-year government bond yield climbed to its highest level since 1997 before closing 2bp higher at 2.44%.

Bank of Japan (BoJ)Governor Ueda signalled a cautious stance on the potential fallout from the US-Iran conflict, prompting investors to scale back expectations for an interest-rate increase at this month’s policy meeting. He said the Middle East situation remains uncertain and the BOJ will watch for knock-on effects on economic activity, prices and financial conditions. Market pricing in the overnight swaps market implies a roughly 30% chance of an April hike, down from about 55% earlier in the day ahead of Ueda’s comments. The BoJ clearly telegraphed its previous two rate hike decisions by indicating the board would discuss whether to raise rates ahead of the meeting.

The US dollar couldn’t sustain its early gains yesterday and continued to retrace against G10 currencies overnight. The move has pushed the dollar index back towards the multiple recent lows around 98.50. The yen underperformed at the margin, posting only modest gains against the US dollar. NZD/USD dipped below 0.5800 early yesterday but has fully recovered, trading above 0.5860 near last week’s highs. NZD/JPY is stronger, but moves across the other NZD crosses were modest.

There was a further sell-off across NZ fixed income in the local session yesterday, reflecting moves in offshore markets. The further fall in the services PMI to 46 – now well into contractionary territory – was looked through by the market, with the inflationary impact of sharply higher oil prices dominating price action. There is now ~80bp of RBNZ tightening priced by December. Two-year rates increased 8bp to 3.56%. The curve continued to flatten at the margin – 10-year swap rates increased 7bp to 4.40%. Government bonds outperformed swaps. Ten-year yields increased 5bp to 4.76%.

There is no domestic data today. In Australia, the NAB Business Survey is scheduled alongside Westpac Consumer Sentiment. In addition, Reserve Bank of Australia Deputy Governor Hauser is participating in a fireside chat and panel discussion this morning. Producer prices are released in the US and provide additional inputs to firm up PCE estimates after CPI was released late last week.

Stuart Ritson is a Markets Strategist at BNZ Markets.