The lull in markets is extending this week. Implied volatility for rates (fx and stocks as well) has fallen to levels last seen in the early part of the year as market participants look past the Middle East conflict. The current mix of reasonably firm US economic data and lower oil prices offer investors considerable comfort on sentiment. As long as the data does not prove to be too strong (NFP > 150k for consecutive months or CPI consistently hovering around 4%), there should be no imminent need for the Fed to tighten just yet. Financial conditions are back into very loose territory as risky assets are buoyant amidst rangebound USD rates, continued optimism on the AI-theme and some moderation in USD strength. Meanwhile, inflation expectations have collapsed across the board. Even 10Y breakevens are now trading below 2.30%. There seems to be a lot of optimism around oil prices staying lower for longer and we suspect that investors may be baking in some odds that the AI drive would eventually lead to productivity gains and hence lower inflation. We think that that too much optimism on low inflation may be in the price and breakevens may be trading on the low side.
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