Rising oil prices weighing on markets

Markets continue to be dominated by an ongoing increase in oil prices – Brent crude has reached $95 per barrel amid another round of attacks in the US-Iran war – which is contributing to a continuing firming of central bank rate hike expectations, rising bond yields, weakness in equities, and a strengthening of the dollar (albeit modest). The euro and sterling have slipped to around $1.1575 and to $1.35 against the US currency, both down around half a cent from yesterday’s best levels. This leaves EURGBP largely unchanged, trading at around £0.8575 this morning.

The firming of central bank rate expectations sees the market now pricing in about 75bps of hikes from both the ECB and the Bank of England by the middle of next year, which is 15-25bps more than was the case a week ago, while about 65bps of hikes is priced in for the Fed over the same period, an increase of circa 25bps in the past week (though of course a more ‘hawkish’ Fed has also been a factor here as well). Government bond yields are heading higher again this morning, having increased for a second day running yesterday, with German and UK 10-year yields up around 3bps at the start of play. Higher bond yields are pressuring equity markets. US indices closed the New York session around 1% lower, while European stocks are slightly lower this morning having shed just over half a percent yesterday.

Headline inflation in the Euro area came in as expected in August, rising to 3.3% from 2.9% in July on the back of  higher energy price inflation. Core inflation (excluding energy and food prices) was slightly lower than expected at 2.4%, down from 2.5% in July,  with a fall in services inflation (to 3% from 3.3%) offsetting a rise in goods inflation (to 1.2% from 0.9%). Overall, the data served to copper-fasten market expectations for a 25bps hike in interest rates from the ECB later this month.

Fed Governor Barr says “with inflation above target for a protracted period, there is a risk of broader price pressures taking hold”. He adds that “if trends in the data give me some confidence that inflation is moderating on a path to 2 percent, then I think we can take a bit more time to assess our policy stance (but) if inflation appears not to be moderating sufficiently, then I think we should act decisively to raise (interest) rates.” The market is currently pricing in a circa 70% chance of a rate hike this month.

It is quiet enough economic data-wise today, with the ADP employment report (August), factory goods orders (July) and the Fed Beige Book in the US the main releases of notes, though of course the fallout from developments in the Middle East will remain a focus for markets.