Oil prices volatile on news of wavering Middle East talks

Oil prices rebounded yesterday after reports that Iran had suspended peace talks. Late last week oil prices had fallen on hopes a peace deal was near – with Brent down to touch off close to $90/barrel on Friday – but Israeli attacks in Lebanon have apparently prompted Iran to pull back from negotiations.  Brent crude oil prices are now back up at around $94.5 per barrel although they are off their intraday high of $97 following comments from President Trump that talks were ‘continuing at a rapid pace’ and that he had a call with Israeli Prime Minister Netanyahu who promised, according to Trump, to scale back attacks on Lebanon. Meanwhile the euro and sterling are trading at about $1.1650 and $1.3480 against the dollar respectively. The dollar had gained on the single currency early on yesterday but lost most of the gains on news of Trump’s comments. EURGBP nudged at little lower, now at about £0.8640, while still in a tight range.

Government bond yields all headed higher on the poor news about the peace talks, with 2-year US yields up 3bps to 4.03% and 10-year yields up 2bps to 4.45%. Yields in the Euro Area and UK headed sharply higher with 2-year German yields up 10bps to 2.6% (10-year up 7bps to 3%) and 2-year UK up 11bps to 4.3%. Driving up European yields was not only oil prices heading higher again but markets pricing in a higher chance of an ECB hike this month (now circa. 95% probability), some hawkish comments from ECB Executive board member Schnabel and data showing 12-month inflation expectations remain well above the ECB target. Yields are, however, moving down on both sides of the Atlantic in early trading this morning, presumably on hopes the situation in the Lebanon will calm.  In equity markets, European stocks ended lower for the 0.3% setting a new all-time high again.

Sentiment in the US was helped by healthy ISM manufacturing data in May. The index rose to 54 from 52.7 in April, beating expectations and is the highest reading since May 2022 and the fifth month of an above 50 print indicating expansion. New orders rose to 56.8, the highest in four months driving the expansion while production also rose on foot of stronger domestic and foreign demand while employment also gained. Surprisingly, the prices paid index fell when a rise was expected due to higher energy costs but a rise in this index may come in later months. Manufacturing in the US appears to have some tailwinds now helped by continued demand from AI data centre buildout.

The ECB inflation expectations data showed 1-year ahead inflation expectations remain elevated at 4%. This is well above the ECB’s 2% target although longer term 5-year expectations remain more anchored at 2.4%. Income growth expectations fell with household already feeling the squeeze from higher inflation with economic growth expectations also deteriorating. Also yesterday were very hawkish comments from ECB executive board member Schnabel who said the ECB ‘can no longer look through this shock. The risk of de-anchoring inflation expectations is rising’. This is a clear hawkish amplification from an ECB member from the ECB commentary that they are debating if the energy price shock from the Iran war was temporary whereas Schnabel clearly believed now it is not and the ECB has to act and supports the case for the ECB to hike rates by 25bps at their June meeting.

For today, on the economic slate we have the May ‘flash’ inflation estimate from the Euro Area where an uptick to 3.2% from 3% in April is expected. Among the speakers we have Fed’s Hammack and Rehn from the ECB and also BoE Governor Andrew Bailey and MPC member Greene.