Risk appetite soured overnight after reports of missile attacks in the Middle East, following Trump’s “Project Freedom” to help ships stuck in the region. Oil prices surged. Global rates are higher across the board; equities weaker

Risk appetite soured overnight after reports of missile attacks in the Middle East, following Trump’s “Project Freedom” to help ships stuck in the region.  Brent crude peaked over US115 per barrel, US and European equity markets are lower, global rates are higher, and the USD is broadly stronger.  The NZD is trading down at 0.5870.

Yesterday morning, President Trump said the US would start guiding commercial ships stuck in the Strait of Hormuz on humanitarian grounds in a mission called Project Freedom.  He warned that any interference in this process would be dealt with forcefully.  Analysts doubted the plan, given the mining of the Strait, while shipowners and said more details would be needed for the plan to be successful.  Iran warned any US interference in the Strait would constitute a violation of the ceasefire.

Since that announcement, tensions in the region have intensified.  There were reports of an oil tanker being hit by projectiles and other reported attacks on commercial vessels near the Strait highlighted the dangers in the area.

Overnight, a wave of strikes from Iran into UAE has followed. While missiles were intercepted across the country, a fire broke out from a drone attack in the port city of Fujairah, a major hub for its oil industry.  This represents the first notable attacks on infrastructure in almost a month.

The US military helped two American-flagged ships transit the Strait of Hormuz in its effort to open a lane through the passageway.  A US admiral said Iran has been firing missiles and other projectiles at vessels in the area and that US helicopters have destroyed small boats going after commercial vessels. Iran media claimed two missiles hit a US warship, but this was denied by the US.

The outbreak of hostilities has soured the mood of the market.  Oil prices surged, with Brent crude up more 6% to above USD115 at their peak and the move has faded only a little as we go to print.

US equities currently show modest falls, with the S&P500 down 0.5%.  The Euro Stoxx 600 index closed down 1%, although that index includes UK stocks and the UK market is closed for a public holiday.  The narrower Euro Stoxx 50 index fell 2%.

Global rates are higher across the board with Germany’s 2-year rate up 9bps against a 5bps lift in the 10-year rate.  US Treasury yields are up 6-9bps across the curve from Friday’s close, with the 30-year rate back over 5%.  The 10-year rate is currently 4.45%, after trading as high as 4.46%, just shy of the March peak.

Central bankers are now free to speak following the policy updates last week.  The ECB’s Nagel, the Bundesbank Governor, said that “if the inflation outlook does not improve markedly [in updated June projections], this would argue for an interest rate hike”. The ECB’s “vigilant wait-and-see approach should not be confused with hesitation”.  Slovakia’s Kazimir argued that a June rate increase is “all but inevitable”.  The market agrees, with a 25bps hike fully priced for June.

NY Fed President Williams gave a balanced speech, arguing that the current stance of policy is well positioned to balance the risks against the backdrop of elevated levels of inflation, mixed signals from the labour market, and heightened uncertainty from the Middle East conflict.

The USD is broadly stronger against the backdrop of weaker risk appetite. The NZD showed further resistance in the 0.5920-0.5930 zone yesterday before falling overnight, to currently sit around 0.5870.  NZD/AUD is back below 0.82 and the NZD shows small falls on other key crosses.

Traders suspect Japan intervened in markets again yesterday, taking advantage of thin liquidity on a Japanese public holiday.  USD/JPY plunged from 157.30 to 155.75 but quickly reversed course to be back near the pre-intervention level.  This highlights the futility of official intervention against fundamental forces (super easy BoJ policy and higher oil prices) which are apt to weaken the yen.  NZD/JPY has traded a wide range and currently sits at 92.3.

In the domestic rates market, global forces resulted in NZGBs falling 1-3bps across the curve.  The 2-year swap rate fell 2bps to 3.52% while the 10-year rate also fell 2bps to 4.29%.  The speech by RBNZ MPC member Gai was academic in nature but had hawkish undertones.  He noted the Strait of Hormuz situation is an example of a shock which lifts the neutral rate, and waiting for inflation expectations surveys to confirm second-round effects are underway is likely to mean waiting too long.

In the day ahead, the RBA is widely expected to hike its cash rate by 25bps for a third consecutive meeting, but following the close vote at the previous meeting, this isn’t priced as a done deal.  The market attributes a 75% chance of a 25bps hike.

Tonight sees the release of US trade, ISM services, and new home sales data and the JOLTs report on the labour market.

Jason Wong is the senior Markets Strategist at BNZ Markets.