Navigating US-Iran tensions
Rates: Navigating US-Iran tensions
US Treasury yields were pulled sharply lower over the past few trading sessions as US-Iran tensions grew. 10Y yields are now at 1.72%, down some 20bps since end-2019. Short-term USD rates have also factored in an increasing chance of Fed cuts towards the second half of the year. Meanwhile, inflation expectations have been steady with the 10Y breakeven rate at 1.74% (close to the average of 1.80% registered over the past five years.
At this point, it is unlikely that military conflict between the two sides would be sufficient to nudge the Fed into easing further. However, from a positioning point of view, shorter duration US Treasuries appear safer than longer-term ones given our medium-term concerns on the US budget.
We are neutral on the curve at the moment. The risk-off mood has bull-flattened the 2Y/10Y segment of the curve by 10bps since the start of the year. We think it would be more interesting to put on steepeners if the spread tightens towards 15bps. With geopolitical risks set to linger, tactical opportunities for outright pay positions in US swaps are appearing.
FX: Wary of tit-for-tat US-Iran retaliation
The market sentiment pendulum continues to swing between recovery hopes and geopolitical risks. Risk aversion had the upper hand this morning. Iran fired missiles into an Iraqi airbase housing US troops, five days after the US drone attack that killed Iranian General Qasem Soleimani. A flight to safety led USDJPY below 108 again and gold prices to USD1600/oz. Interestingly, Brent crude oil prices did not spike above USD70/oz. For now, the US-Iran conflict is seen hurting demand with no imminent threat of oil supply disruptions.
The Dow Jones Industrial Average closed 0.4% lower despite of a stronger-than-expected bounce in the ISM non-manufacturing PMI in December (55.0 actual vs 54.5 consensus and 53.9 previous). Earlier optimism over the signing of a Phase 1 trade deal receded and led the offshore USDCNH above 6.95 again. Export-led Asian currencies such as the Singapore dollar and the South Korean won have started to give back gains on the China-US trade truce. More payback is possible if US and Iran head for tit-for-tat retaliation.
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