The dominant question for markets this week was whether the Iran conflict, which has driven Brent crude up roughly 50% since late February and rewired every major central bank’s reaction function, might be approaching an end. By Wednesday, President Donald Trump was describing negotiations as being in the “final stages”, Brent crude had fallen 5.6% in a single session to close at $105.02 per barrel, and reports indicated that three supertankers had transited the Strait of Hormuz for the first time in weeks. WTI fell below $100. Markets, having spent most of the year pricing for the war to drag on, began to permit themselves a degree of cautious optimism, although the broader repricing of central bank expectations has barely begun to unwind.
Beginning with the UK, the dominant domestic release was Tuesday’s headline inflation print for April, which came in materially below expectations. Headline CPI fell to 2.8% from 3.3% in March, and the mechanical driver was straightforward: the 7% cut to the Ofgem energy price cap that took effect on 1st April fed directly into household electricity bills, which are now lower than a year ago for the first time in some while. The underlying picture is messier. Motor fuel prices rose sharply as the conflict pushed pump prices up, while food inflation, in the Governor’s words on Wednesday, was “surprisingly benign”. The Bank of England has guided that inflation is likely to sit between 3% and 3.5% through the second and third quarters, so April may prove the trough rather than the new direction of travel.
Turning to the labour market, Monday’s data offered fewer comforts. UK unemployment rose to 5.0% in the three months to March, up from 4.5% a year earlier, and the more timely payrolled employee data showed a fall of around 100,000 in April alone. Vacancies dropped to their lowest level since early 2021. Wages are still growing faster than prices, just barely, leaving real pay growth close to flat. The labour market is cooling more quickly than the inflation data alone would suggest, and that matters for what the Monetary Policy Committee does next.
That tension was the central theme of Andrew Bailey’s appearance before the Treasury Select Committee on Wednesday afternoon. The Governor told MPs that, but for the Iran war, the Bank would probably have cut rates once or twice this year, and that inflation might have reached its 2% target last month. He described the conflict as the dominating change in the landscape for the British economy. In effect, Bailey argued, policy has been tightened by the simple act of removing the cuts the market had previously expected. He was careful not to commit either way ahead of the 18th June meeting.
In the US, the news was, if anything, more striking. The FOMC’s April 28th to 29th minutes, released on Wednesday evening, revealed the largest dissent at a single meeting since October 1992. The committee held the federal funds target range at 3.5% to 3.75% on an 8-4 vote. Three regional Fed presidents (Hammack, Kashkari and Logan) objected to retaining language that hinted at easing, while outgoing Governor Stephen Miran dissented in favour of a 25bps (0.25%) cut. Most participants flagged that some additional tightening would become appropriate if inflation continued to run persistently above target. Futures markets have responded by pricing the odds of a rate hike by December roughly level with a hold.
Linked to all of this, the meeting in question was Jerome Powell’s last as Chair. Kevin Warsh was confirmed as the new Federal Reserve Chair by a Senate vote of 54-45 on 13th May, the narrowest margin in the modern era, with Powell remaining on the Board as a Governor (an unusual arrangement; the last time a Fed Chair stayed on was nearly eighty years ago). Warsh, who has called for a different policy posture and a fresh approach to the Fed’s framework, chairs his first meeting on 16th to 17th June.
Away from the central banks, the most arresting story of the week was in long-dated government bonds. On Friday last week, Japan’s 30-year JGB yield broke 4% for the first time since the tenor began trading in 1999, with the 20-year at its highest since 1996 and the 40-year at a record. By Monday, the US 30-year Treasury yield was at its highest in nearly a year, the UK 30-year gilt yield at its highest since March 1998, and the German 10-year Bund at its highest since May 2011. The move reflects two related anxieties: that inflation will prove stickier than central banks had hoped, and that government finances around the world will need ever more long-duration paper to fund themselves.
In a similar vein, the People’s Bank of China kept its Loan Prime Rates unchanged on Wednesday, leaving the one-year rate at 3.0% and the five-year at 3.5% for a twelfth consecutive month. With Chinese first-quarter GDP coming in at 5.0%, at the top of Beijing’s target range, and energy-driven price pressures rising, the case for easing is weaker than it looked at the start of the year.
UK retail sales released this morning declined by 1.3% month-on-month, a worse outcome than expected. On top of weak retail sales UK public sector net borrowing was higher than anticipated. Typically, this may have led to a sell off in government bonds, however, positive comments from Andy Burnham around sticking to fiscal rules and acknowledging “there needs to be a plan to get debt down” has supported UK bonds, leading to falling yields.
Looking across the week as a whole, bond markets remain under pressure, with long-end yields in Japan, the UK, the US, and Germany all at levels not seen for years and, in several cases, decades. Headline inflation in the UK has eased, but the underlying picture remains tightly bound to the conflict and the oil price. Equity markets have held up better than the move in yields might suggest. The variable we continue to monitor most closely within portfolios is the duration and resolution of the Middle East conflict, which still sets the tone for everything else.
Mark Wilson, Investment Analyst
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