Iran conflict sends shivers through markets: rate hikes loom?
The Strait of Hormuz is once again a flashpoint, and the reverberations are being felt far beyond the Middle East. Escalating tensions stemming from the Iran conflict have triggered a dramatic reassessment of inflation expectations and interest rate policies, sending shockwaves through European and U.S. financial markets.
Energy crisis fuels inflation fears
The blockade of the Strait of Ormuz, coupled with attacks on energy infrastructure in the Persian Gulf, has dramatically altered the landscape. What was once a predictable inflation outlook is now clouded by uncertainty, forcing central bankers to reconsider their strategies. The usual barometers of central bank activity—the pronouncements of Federal Reserve Chair Jerome Powell and European Central Bank President Christine Lagarde—have sparked a flurry of speculation and anxiety.
It’s a peculiar dynamic. The United States, a net exporter of oil and gas, and Europe, heavily reliant on U.S. energy and a significant importer, find themselves on opposite sides of the equation. Yet, the market isn't making distinctions. The Federal Reserve currently holds interest rates between 3.5% and 3.75%, a considerable advantage over the ECB's 2% deposit rate, but that hasn't prevented a rapid shift in investor sentiment.
The catalyst was the outbreak of conflict on February 28th, but the recent intensification has truly accelerated the change. The CME’s Fed Watch index, a reliable gauge of market expectations, paints a stark picture. Just a month ago, a rate cut in March held a 30% probability. That figure dwindled to less than half in just fifteen days, then plummeted to a mere 2.1% last week. Today? Zero. The pendulum has swung with a velocity rarely seen outside of major crises.
Consider this: Seven days ago, the Fed Watch barometer offered no chance of rate hikes. Now, the probability has surged to 10% and is expected to continue its ascent. This isn't just a minor adjustment; it’s a tectonic shift in market perception.
Euribor rockets, shadow banking concerns mount
The European response has been particularly acute, intensified by the region’s precarious energy position and historically lower interest rates. The Euribor, a benchmark for mortgage rates, has exploded, with wholesale money markets registering a significant jump since Friday. The 12-month Euribor is poised to breach the 3% threshold at a pace reminiscent of the 2008 financial crisis, dragging the entire interbank rate curve along with it.
While the escalating crisis in the Persian Gulf and the resulting energy crunch are primary drivers, there’s a deeper current at play. Credit markets are grappling with their own anxieties, compounded by a separate crisis affecting direct fund loans to companies. Prominent firms, including Apollo, BlackRock, and Blackstone, have restricted redemptions in several of their funds, awaiting a calmer environment.
The so-called ‘shadow banking’ sector’s woes are, paradoxically, impacting traditional banks—institutions that have invested in and lent to these very entities. Adding insult to injury, Mastercard recently reported a substantial financial hit stemming from the collapse of Banco Master and fintech Will Financiera in Brazil.
Jan von Gerich, chief analyst at Nordea, succinctly captured the mood: “The 12-month Euribor registered its largest increase since 2008. In an uncertain market, Euribor rates fluctuate considerably, but upward pressure on interest rates isn't so strong.” He added, “The evolution of the situation in the Middle East is also influencing the evolution of Euribor rates.”