Oil Prices Retreat, Bonds Struggle on Hawkish Rate Repricing as Iran War Rages

Oil Prices Retreat and Bond Yields Surge Amid Middle East War and Rate Fears

Market Reactions to Middle East Conflict and Central Bank Policies

By Rae Wee

SINGAPORE, March 20 (Reuters) - Oil prices eased on Friday while bonds were nursing losses, after global central bankers sounded the alarm on inflation risks stemming from the ongoing war in the Middle East that has sent markets into a tailspin.

Following a hectic week of monetary policy meetings across effectively the Group of Seven (G7) nations and others, the key takeaway for investors has been the prospect of a more aggressive policy path.

Central Bank Responses and Rate Expectations

Traders are no longer expecting a Federal Reserve rate cut this year, a hike from the Bank of England next month is seen as a coin toss and sources said the European Central Bank may need to begin discussing rate increases in April and possibly tighten policy in June.

"There's a lot of value in the signal," said Vishnu Varathan, Mizuho's head of macro research for Asia ex-Japan, of the hawkish rhetoric from central banks this week.

"It's a messaging to markets that we are on top of this, you don't need to send yields unnecessarily higher, because... the yields are already starting to do the work for them."

Bond Market Volatility

A rout in global bonds pushed yields to multi-month highs on Thursday, though the selloff abated in Asia on Friday.

Trading of cash U.S. Treasuries was closed due to a holiday in Japan, but futures edged marginally higher.

The yield on the two-year U.S. Treasury note, which typically reflects near-term rate expectations, had jumped as much as over 20 basis points in the previous session.

"Probably every day that goes by without an end to the war or clear positive steps increases the chances of that more adverse scenario for the bond market," Thomas Mathews, head of markets for Asia-Pacific at Capital Economics, said of the possibility of rate hikes from major central banks by the year-end.

For the month thus far, Germany's two-year yield has already risen some 56 bps, while yields on two-year British gilts have jumped 88 bps.

Energy Markets Under Pressure

Oil Price Movements

Energy Chokehold

Brent crude futures were down 3% at $105.43 a barrel on Friday while U.S. crude fell 2.2% to $94 per barrel, after leading European nations and Japan offered to join efforts to secure safe passage for ships through the Strait of Hormuz and the U.S. outlined moves to boost oil supply.

Still, both remained well above levels prior to the U.S.-Israeli war on Iran, having risen more than 40% this month. [O/R]

Natural Gas and Geopolitical Risks

Natural gas prices have also soared, with those in Europe surging as much as 35% on Thursday, as Iranian and Israeli strikes targeted some of the Middle East's most important gas infrastructure.

That prompted U.S. President Donald Trump to tell Israel not to repeat its attacks on Iranian natural gas infrastructure.

"Even if the U.S. leaves (the conflict), Israel might not leave, and there may still be some strikes and Iran will retaliate, maybe at a lower volume," said Alicia Garcia-Herrero, chief Asia-Pacific economist ​at Natixis.

"But this means that the Gulf will still be under pressure... so oil prices will not go back to $60, they will maybe stay at $90, at least until the end of the year. So the shock is already unavoidable."

Global Equities and Currency Markets

Stock Market Performance

Shares Steady, Dollar Falls

MSCI's broadest index of Asia-Pacific shares outside Japan rose 0.18% and was set for a weekly gain of roughly 0.7%, snapping two straight weeks of losses.

The retreat in oil prices on Friday helped stabilise the market mood, though moves remained volatile.

Nasdaq futures rose 0.3% while S&P 500 futures advanced 0.37%, after closing lower in the overnight cash session. EUROSTOXX 50 futures were up 0.87%, while DAX futures jumped 0.8%.

Currency Movements and Central Bank Influence

The dollar was meanwhile set for a weekly loss of more than 1%, as investors priced in steeper rate hikes from other central banks this year as compared to the Fed.

The euro last bought $1.1570, having jumped 1.2% on Thursday, while sterling was steady at $1.3424 after a 1.3% rise overnight.

Even the yen, which was on the cusp of 160 per dollar in the previous session, found some reprieve and last stood at 157.85.

The Japanese currency was also supported by some hawkish comments from Bank of Japan Governor Kazuo Ueda on Thursday, after the central bank held rates steady but maintained its bias for tighter monetary policy.

Yusuke Miyairi, Nomura's JPY FX and rates strategist, said that while Ueda may have left the door open to a rate hike in April, it remains "premature" to conclude that such a move would be coming.

Gold Prices

Elsewhere, spot gold was up 0.8% to $4,686.97 an ounce. [GOL/]

(Reporting by Rae Wee; Editing by Sam Holmes)