Last week, we described the decline in long-term US yields since the start of the year. A fairly counter-intuitive move given the many factors pushing in the opposite direction.
A weekend that changes the narrative
"The narrative shifted from" the economy is strong" to "we're all going to be unemployed", Apollo's chief economist, Torsten Slok, summed up in a note published on Saturday.
Indeed, fears of disruption from AI had until now been the central theme in equity markets. That climate translated into corrections-if not outright purges-in certain sectors: software, real estate services, private equity… Late last week, that narrative was reinforced by an announcement from Block, which laid off 40% of its employees as part of a reorganization aimed at integrating AI.
But since the outbreak of the conflict in the Middle East over the weekend, the conversation has clearly changed. Oil has surged, and everyone is worried about the inflationary impact of this shock.
Those concerns are showing up in higher yields. France's 10-year OAT jumped 20bp, the Bund 15, and the US 10-year 16 since Friday. Long-term yields are rising because inflation expectations are rising. And short-term rates as well, because investors are reassessing their expectations for rate hikes/cuts from central banks.
The ECB on the front line
Europe is on the front line of this shock. European stockmarkets have fallen sharply for two days, while moves have been more limited on Wall Street. European countries are more exposed than the United States because they are more sensitive to energy shocks. All of this brings back some unpleasant memories of 2022 and the consequences of Russia's invasion of Ukraine. The surge in energy prices was a shock to the European economy.
To sum it up briefly, since 2022, Europe has moved away from its dependence on Russian hydrocarbons. But it has increased its reliance on other countries, notably Qatar, one of the world's leading producers. In fact, it is in European gas prices that the impact of the current conflict is most visible. In Amsterdam, the TTF price has nearly doubled in two days. Timing is fairly bad for European countries, which are coming out of winter with low gas inventories.
In 2022, the energy shock forced European states to take measures to limit the impact of higher prices on their economies-decisions that were very costly for public finances. The sharp rise in long-term yields is probably also explained by that prospect.
Until now, the ECB's central scenario was one of a status quo in 2026, while staff projections pointed to inflation slightly below target (1.9%) and solid growth. But the possibility of a rate hike is now back on the table. The ECB's chief economist, Philip Lane, warned this morning in the Financial Times that a prolonged conflict in Iran could trigger a surge in inflation.
