Iran ceasefire: What next for markets and the economy?

Let's talk to you about what we're going to be talking about today. As you'll notice from the studio, we've got a couple of speakers here. We've got people down the line too. These are the sort of things we're going to be talking about. So firstly, we're going to talk about energy flows coming through the straighter formus and how quickly that can recover. Supply chains obviously coming under pressure as well through the conflict. We're going to talk about commodities that have been affected so far and what's the extent of the supply chain damage has been thus far. We're going to talk to Ewa Manthey, who's our commodity strategist about that. We're then going to talk about central banks. Central bank rate hike expectations have been pared back over the last 24 hours or so as oil prices have come lower. Are rate hikes off the table? Let's see. We're going to talk to we're going to talk to Carsten Brzeski, who's our global head of markets about that. What we'll do then is we're going to talk about markets. As you can see, we've got Chris and Michiel here in the studio. We're going to talk about what's been driving rates markets. What's been driving FX and sort of where euro dollar and bond yields can go later in the year. Firstly, though, let's talk. Let's see what you think. So we're going to start off with a poll. And we're going to ask you where you think oil prices are going to be in one month's time. Is it below $60 a barrel, $60 to $80 a barrel, $80 to $100 a barrel, $120 a barrel, $120 to $140 or above $140 a barrel? So a lot of options. But tell us what you think. And we're going to come back to the options in a few moments time. Carsten, though, I want to start with you here. We're talking about scenarios through the conflict. Both sides have agreed to start talking, of course, but there's any number of ways that this can go. And, you know, as I say, we've been looking at scenarios throughout this conflict. How do we think about scenarios going forward? Yeah, thanks, James. So I'll say the camera movement is almost erratic as some of the political announcements over our recent month. But as you said, we'll get to the bottom of that. Well, to just take you a little bit into ING's research forecasting kitchen. We are in the midst of preparing a full set of new forecasts. Next week will be the moment in which we publish then our April monthly. And then to get there, we have currently developed three broader scenarios after the ceasefire result or agreement. One, I would call this currently also what happened over the last 24 hours, I would call this really the positive outcome. And that would be that we will really see that the ceasefire that will be applied, that at the end of the ceasefire period, we will really have an agreement. It would probably also really involve many of these 10 point programs prepared or proposed by Iran. But it would also then be followed by an opening and a more broader opening of the Strait of Hormuz. And would have to be some kind of agreement as well, which would exclude Iran from from preparing or from continuing to build nuclear nuclear military missiles. So that's the more positive outcome. What currently looks like our base case scenario would be one, and I think we're clearly in that already, where it will not be a full out ceasefire period. We will see flaring up within the ceasefire period, probably the period of the negotiations will be extended, meaning that also in markets we will see again a flaring up of uncertainty, flaring up of tensions, of higher prices. And then in the end of the ceasefire period, I wouldn't exclude that then this would also mean more military attacks, at least partially. So and then at the end of a longer period, then in the first scenario, we would then get also to some kind of agreement. And at least that would be in our scenario, an agreement which would not include Iran taking fees for for for vessels crossing the Strait of Hormuz. And then the third one is, and that's also where there are no limits to imagination. And that's the the adverse scenario, the worst case scenario, clearly one in which the the ceasefire period completely fails in in which we are back to well to to full military action. And that's where then probably the announcement that President Trump made over Easter would would come true, which then would also in turn mean that that oil and gas production in the Middle East would be would be destroyed for good. A certain portion would be destroyed for good. And clearly, we would then also be looking into into much more adverse impact for not only energy, but also for the global economy. We've sorted out our jumping cameras. So apologies for that. But let's come back to ever now. So let's dive into these some of these issues in more detail ever. I mean, a lot of ifs and buts, I guess, is Carsten's saying, right. But let's assume for the minute that we do get some kind of reopening of the Strait of Hormuz over the coming days and weeks. How quickly can energy flows resume? We hear a lot about that there's loads of ships that are full, ready to go, backed up through the Gulf. But also we know that a lot of energy infrastructure has been damaged as well as across the region. So how quickly can things ramp up again, both in terms of flows, but also production? I mean, if you look at the price action that we saw in the last 24 hours or so, the price move tells you how much risk premium had built up in the markets. But it doesn't really tell you that the physical situation has materially changed. Right. So, yes, the markets welcomed the ceasefire. We saw Brent dropping sharply below $100 a barrel and gas sold off even harder. So that move was justified in the sense that the market was heavily priced for a prolonged and worst case disruption. And what we've seen since yesterday, since the ceasefire was announced, is a repricing of tail risk, not necessarily a signal that flows are normalizing again. So from here, everything hinges on Hormuz and specifically whether the ceasefire translates into a safe and repeatable transit rather than a one-off or selective crossings for vessels. And so far, it hasn't. Even after the ceasefire announcement, Hormuz remains largely blocked. Only a handful of ships have been seen exiting the Gulf, which compares to roughly 130 a day before the conflict began. More than 800 vessels are still trapped inside. And most of them are waiting to leave. And that really tells you that there is no lack of supply or shipping capacity. There's just a lack of confidence. And we've heard ship owners and insurance, they have been very clear that the ceasefire headline just isn't enough for them. They need clarity on how the passage works in practice, who will authorize the transit, what inspections look like, what happens if conditions change mid-voyage as well, and whether the transit becomes effectively permission -based or whether there's going to be some kind of toll. And until that's resolved, most operators will probably remain cautious. And that caution has already been validated. We've seen reports yesterday and this morning, the tanker passage was halted again, following more strikes yesterday. And that's exactly the type of development that keeps the traffic frozen. So for the market to move on, it doesn't really need a full breakdown of the ceasefire. It's just enough uncertainty to make the crews and insurance and charterers uncomfortable to take that transit again. Is this a turning point for oil markets ever? Short answer, not yet. So this looks more like a relief rally than a genuine turning point for oil markets. This ceasefire has clearly removed the most extreme downside risk, which was a scenario where flows through the Strait of Hormuz remain shut for an extended period. And that's why we've seen such a sharp repricing lower in energy prices. But this move reflects more the unwinding of that risk premium rather than a fundamental reset in supply and demand. So for this to be a true turning point, we would need to see sustained and uneventful flows through the Strait of Hormuz, not just the headlines about reopening. So on the production side, most of the curtail output can, in theory, return, which limits long-term supply damage. But inventories are lower, buffers are thinner, and the system has been really stressed. So that makes the oil markets more sensitive to setbacks than they were before the conflict began. So for now, this ceasefire, yes, it buys more time and reduces the near-term time risk, but it doesn't yet mark a definitive shift for the energy markets. So if we see a breakdown in talks or a renewed threat to shipping, it could see the risk premium return very quickly to the markets. And Eva, let's stay with oil markets just for a second, and let's check in with a poll that we've put out. We asked you where you thought oil prices would be in one month's time. And most of you think kind of in the same area where we are now, so $80 to $100 a barrel. 30% of you think between $100 and $120 a barrel. So yeah, interesting stuff. Now, Eva, you look at a whole range of commodities, right? And I think one of the things us as economists are trying to figure out of the conflict so far, we've had six weeks of conflict. What's the damage been to supply chains and sort of, you know, you look at it through the lens of metals. Has there been lasting damage, which, you know, when we think about inflation, for example, could be an issue a few months down the line? I know you've been looking at aluminium, for example. Yes, I think the last six weeks have had a lasting impact on supply chains. Even if you're not yet talking about whole structural research for the supply chains. And aluminium is a very good example of why. And also why those risks also extend beyond just metals markets. So aluminium is uniquely exposed because the Gulf is not only a major production centre, but also a critical logistics and transit hub. Over recent weeks, disruption has hit both ends of the value chain at the same time. So we've seen interruptions to aluminium shipments into the region, constraints on aluminium exports out and a sharp rise in freight costs, insurance, premiums and also all the delivery uncertainty. So for end users, that combination is much more disruptive than a simple price move higher. And that production impact is now real rather than hypothetical for aluminium. So EGA smelter alone represents around 1.6 billion tonnes of annual primary aluminium capacity. And the company has been very clear that the full restart could take up to 12 months. And if you add to that the earlier reductions we've seen at other smelters, we are looking to close to 3 million tonnes of capacity taken offline already, which is roughly half of the Middle East production and around 5% of global supply. And that's material in the market that was already tied prior to the conflict. And what makes this particularly important is that aluminium smelting is not easily reversible. So once you see those pot lines shut and the metal freezes, those restarts become lengthy and capital intensive and really uncertain. So some of that lost production we've seen over the past six weeks is probably unlikely to be recovered quickly, even if we see logistics normalising. So where you see this feeding through most clearly is downstream. For sectors like auto, this is critical. So car makers don't really need vast volumes of aluminium, but they need the right grade and they need it delivered on time with very little tolerance for any kind of disruptions. So far, the industry is managing, they're drawing down inventories, diversifying sourcing and absorbing higher costs. And that's why we haven't seen an immediate production shock so far. But of course, the system is clearly more fragile now. If we see flows through home boost normalising and remaining stable, some of these pressures should ease. But if disruptions persist or they reemerge, the risk escalate quickly and not just for aluminium, but for a wide range of industrial supply chains. Great. Thanks a lot, Eva. And we're going to take that forward into inflation in a second. But before we get to Carsten, let's ask you what you think about the ECB. Are they going to hike rates this year? Markets have obviously been flirting with it. So the question is how many rate hikes or cuts to expect from the ECB by year end? Is it one, two, three or four? No rate hikes or cuts or one or more rate cuts. That's the final option. Come back to the results in a second. Carsten, before we get into the ECB, let's talk about inflation. Energy prices, even after them coming lower, oil prices coming lower, still something like 30 percent higher. Interestingly, natural gas, much more contained, which is a clear difference, obviously, to the 2022 inflation shock. But when you're sort of tinkering around with your spreadsheet, what's the first order implication of this on inflation for the next, say, three to six months or so? Yeah, well, I will not share all information because people should still read our monthly next week. So keep some secrets alive. But I think currently we would see inflation, headline inflation between three and four percent looks likely. Like like like like ever described. So we have, of course, this is whatever described on commodities or metals. This, of course, an inflation wave that is already on its way to reach the European economy. And there is one. And this already kind of felt by everyone going to the gas station currently. So gasoline prices are actually as high or even higher than 2022. Now we made some estimates back of the envelope. And in most European countries, if if gasoline prices would stay at their current levels, the hit to purchasing power would be equal or worse than what we had in 2022. That is one. And then we will see kind of the knock on effects on transportation costs, on food prices as well, but also on on all products using oil. And then this is in the in the construction sector. This is in other sectors as well. So this is clearly where at least one big wave of inflation is in the in the making. And three to four percent, I think, currently looks looks looks like a good estimate for for for for for euros, euros on headline inflation. I think what's what's what's what's also is important to to remember then when when we have this this first wave of of inflation reaching the economy. And the next question is how much can companies actually pass on to to to final consumers? And here I think the the risks of a third and fourth round effect. So namely, really seeing a de anchoring of inflation expectations, seeing a wage price spiral really unfolding are currently much lower than they were in 2022. And yes, indeed, I know I never never trust an economist who tells you this time is different. But when you look at the state of the labor market, it is different than in 2022. And also when you look at the entire European economy, it is in the in the weakest state currently than than coming out of the lockdown in 2022. And then five final argument also just had this morning again, German industrial data for for February. And I think there was also a reminder that even before the war started in the Middle East, this this this hoped for recovery of German of German manufacturing sector is. I think we might have I think we may have just lost cast in there. But what was the momentum and much slower than. Sorry, we lost you for a second there, cast in. But I think that the gist of your answer there was a bit of a first wave of inflation coming three and a half to four percent inflation. But second round effects this time much less likely and sort of bearing that in mind, let's fast forward to the the ECB's decision in just a few weeks time. And in fact, before we do that, let's look at the poll results, because this is quite interesting. Very even split between different options. So markets are currently pricing in the region of two rate hikes this year. So 30 percent of you agree with that. One rate hike, similar number and a very similar number still marginally ahead. No rate hikes or cuts. Now, I think, Carson, you're more in that latter camp by the sounds of it. You know, markets kind of overestimating the willingness of the ECB to hike rates. But, you know, when we get to that April meeting, I suppose, am I right? Do you expect a hike or not? But also, even if they don't hike, you know, do you expect the ECB to try and talk down market expectations or do you think they need to talk tough? I think when it comes to the April meeting, the answer is much easier than when it comes to the June meeting, in all honesty. So for the April meeting, I only see a very, very slight chance of a rate hike. And why is that? Because we will hardly have new data, hard data. So what we will have is really only margin inflation data. On the day of the ECB meeting itself in April, we will then only just have seen the first estimate of GDP growth in the first quarter. So the assessment of the European economy in late April will simply be one in which sentiment has been weakened, in which inflationary pressure has increased, in which we have stagflationary pressures being imposed on the European economy. But then it would be too early for the ECB to really act. And also, as long as we're then still in our probably new base case scenario, namely one in which an opening of the Strait of Hormuz is unfolding, I see very little reason for the ECB to hike in April. The ECB will then also actually do very little to talk down market expectations. Why is that? Because market expectations are helping the ECB to also cushion inflationary pressures because higher bond yields really leads to a tightening of financing conditions in the eurozone. So adding to a more restrictive monetary policy. At the same time, there's also something that market participants do not always have on their radar screens is that that excess liquidity in the eurozone system is also coming down due to a shrinking of the balance sheet of the ECB. So there is also already in, well, non-interest rate tools, there is already a tightening of monetary policy happening. When we then move forward to the June meeting, I think what will be crucial by then? It is not that an ECB will just blindlessly react and hike interest rates just for the sake of showing that it's really a diehard inflation fighter. What is crucial is inflation expectations and its core inflation. But if by the June meeting, we really see that that core inflation, which currently is still around 2%, so if core inflation has started to crawl up, if there is also really more evidence that inflation expectations are starting to de-anchor, I think there is a clear likelihood that the ECB would hike interest rates. Could we see and not forget that final word that at some point in time, we have market expectations of, I think, close to four rate hikes by the ECB this year? I must say, I must say, I'm lacking the imagination to see really four rate hikes by the ECB. Why is that? Because first of all, it's really, we have an energy price shock. So adding to that, 100 basis points of rate hikes would really choke off a very fragile Eurozone economy. And on top of that, could also risk undermining financial stability, given that we know that what was always kind of preluding former financial market corrections, it has always been a tightening of monetary policy. And I cannot see the ECB really being open-eyedly, willing to accept creating a new financial market turmoil, just by fighting or by trying to fight what currently still is only an energy price shock. Great. Thanks a lot, Carsten. Let's talk about markets now. We're going to get into those market rate hike expectations that Carsten just mentioned. But I want to start with you, Chris, on FX. If we zoom out a little bit, what's the FX market making of everything? Yeah, so we went into this, into kind of February. The dollar had been pretty soft. Kind of the consensus view had been we're going to see a benign decline in the dollar this year. We're going to see synchronised global growth. Markets were overweight. Emerging markets in Europe and pretty kind of long Eurodollar. That all kind of not quite went up in smoke because I don't think there's been a complete capitulation of those positions. But there's been an unwind. And I think to sort of answer my own question of should we expect a complete retracement of maybe the 3% dollar rally we've seen in March? Should we, based on what we've heard yesterday, expect the dollar to hand back all of those gains? And I think the answer is probably no, given everything we've heard today. There just isn't that certainty of where oil prices are going to be and what that means for the stagflationary shock, which has really challenged the consensus of synchronised kind of global growth this year. And Mikil, on those kind of rate hike expectations that we were discussing earlier, I mean, not just for the ECB, but for everyone as well, right? I mean, I don't think we're the only people that are looking at that rate hike pricing and sort of scratching our heads a little bit, looking at it kind of a bit of extreme. I mean, what's been driving those expectations? Is it simply oil prices or is there sort of market factors at play, liquidity, for example? Yeah, sure. So first of all, it's very simple at the moment almost to predict where rate markets are because they've been almost entirely driven by the oil price. And it's quite ironic. You've got such a complex conflict going on. And yet I could predict every day on my screen, oh, here's oil. This is probably where the front end should be. These are the amount of rate hikes priced in. Done. And that's still being the principal driver. But there's also this question about liquidity conditions influencing this as well, because as Karsten highlighted, it's very difficult to see an ECB hike three times, maybe four times. It doesn't always resonate with the idea of a supply shock, how that interacts. And what we see, a lot of market players are actually taking more wait and see approach, which is really withdrawing liquidity from the market. And that might mean you also distort market pricing. So you could see on your screen, yes, markets are pricing in three rate hikes. But a matter of fact, it might be more reflective of, say, two rate hikes if you account for these liquidity effects. So I think that's really important to keep in mind when trying to draw conclusions from pure market pricing. Yeah, I think that liquidity point is very interesting. Chris, FX markets have obviously also been driven heavily by oil over the past few weeks as well, maybe less so some of the traditional drivers of currencies. Think about things like interest rate differentials, for example. I mean, how do you sort of think the market will be trading over the coming weeks? And if we do start trading on some of those more traditional drivers, what should we expect? Yeah, I mean, I think interest rate differentials are taking a kind of backseat. It's all been about oil. But I kind of the feed through from oil to FX markets, not only through things like terms of trade, and obviously the greater costs that Europe and Asia have to kind of pay for energy, but it's things through like real interest rates. So nominal swap rates adjusted for inflation expectations. And that's where inflation expectations are driven by the oil prices. And actually, there is a really decent relationship between, for example, euro dollar and real interest rate differentials. And I think it's really important for the ECB, I think coming up into April, I think they've got to be pretty careful because if oil prices kind of stay high, but they try and kind of get away with it and saying, well, we're very worried, but we're not going to hike. And actually swap rates come off. Maybe some of those two to three hikes are kind of priced out, but inflation expectations stay high. Those euro real interest rates can come lower and leave euro dollar kind of vulnerable. So, I mean, this year, I mean, we're not looking for a full repeat of 2022 when euro dollar went to parity. And that was not only driven by the terms of trade, but really by the Fed. The Fed decided from having very negative real interest rates, we need to fight the inflation shock with very positive real interest rates. We're not expecting that from the Fed. And that's why we think maybe euro dollar can hold around above 115 through the first half and maybe end the year at 120. But I think the risks, I think the next couple of months perhaps are on the downside still for euro dollar. And if the Fed's not coming in and being aggressive, where does that leave emerging market currencies? Yeah, so the market have been kind of overweight, like emerging markets, and some of the very popular trades like the RAND, some of the others, obviously Egypt was right in the center of this kind of shock. And that's sort of 12% kind of sell off. But I think one of the interesting points is which currencies had a good crisis crisis and things like Brazil only had like a 3% drawdown. You get really high interest rates over there. So that's a good crisis. But I think one of the big stories is China. So the renminbi, normally during crisis, the People's Bank of China fix dollar renminbi flat and say, nothing to see here. Please look elsewhere for your kind of action. But actually, on the first day, I suppose yesterday with a ceasefire, they fixed dollar renminbi lower. And I think they've really positioned the renminbi or positioned themselves as like the adult in the room and want to maybe they see a great opportunity of like de-dollarization and really positioning the renminbi as a reserve currency of kind of choice. So I think the renminbi has had a pretty good crisis. And I think Lin Song, our greater China economist, has just upgraded his renminbi forecast for this year. Yeah, interesting. And I'm conscious of the time. We are going to carry on a little bit. So much good stuff to talk about. But hopefully you can stay with us for a little bit longer. Yeah. Mikhail, I mean, one of the things whenever we get a shock like this, energy shocks, COVID, the concern is always, you know, when markets are so volatile, something's going to come out of the woodwork. You get a period of financial stress emerging. Have we seen much of that this time? What sort of things are you looking at to gauge it? So to be honest, I find markets remarkably resilient so far. And the most simple way to look at it is just look at the equity markets. So just look at the S&P 500, look at the stocks market. And you can see, yes, it's down. If you zoom out, would you say this is a major global crisis? Probably not, because they really came from record highs. And I think that really resonates with this idea. A lot of investors have been wait and see so far, really with the idea this is going to be a short-lift crisis. And once this is over, business as usual. And I think that mentality has really prevented a big panic, knee-jerk reaction. You do see over time, as the conflict lasts longer, every week we do see risk sentiment deteriorate a bit. So I think it's also a bit of a warning. If we do not resolve this conflict soon, we might still see more impact from a market sentiment perspective. And I think markets have also been resentful. If you look at the rates market specifically, safe haven flows into bonds. You see a bit happening, shorter-dated bonds, which is really a classic place to hide from turbulence. But again, mild reaction. Liquidity conditions still very healthy, because that's usually a bit the fear that somewhere there's not a lot of liquidity in the system, which could indeed trigger something worse happening. Not the case. Central banks have not shown really a significant increase in uptake of liquidity facilities. So, so far, not major warning flags there. But as the conflict takes longer and longer, I do think markets could get a bit more nervous. Thanks, Michael. We've got lots of interesting questions coming through. I mean, there's a sort of common trend on some of them where we're talking about government bonds. You know, yields have also fallen, sort of a central bank interest rate. Expectations have been pared back over the last day or so. I mean, what does that tell us? When you've been looking at longer-dated bond yields, what does that tell us about how investors are looking at the current crisis? Yeah, so I think important to start with, all the moves throughout the entire curve, so that means sort of short-term, two-year rates, and the longer-term, 10-year, have really been driven by this idea of ECB, rate hike expectation, Bank of England rate hike expectation, Fed rate holding rate longer. So really driven by the front end. But what I'm most closely looking at at the moment, how the longer-dated bonds are now reacting. Because what you'd see already, for example, five-year yields, could actually see a bit of a flattening. So what that means is the belly of the curve starts outperforming. Simple terms, over the medium-term, markets might be turning a bit more pessimistic about the growth outlook. And I think that's key to look at, what if we now have things go back to normal, instead of oil prices or closer back to normal, will there already have been damage in the growth outlook that will then actually pull down, say, five-year, 10-year government bond yields lower? Because so far, it's really not been about fiscal risks. It's really inflation and growth-driven. We've got a question here, Chris, about the petrodollar. We've been talking a lot about this this year, right? De-dollarization on so many different ways. I mean, is there still a future for the petrodollar? Is much going to change? Are we going to see sort of more energy flows priced in other currencies? I was just thinking that on the way into that, actually. I think we should be writing a report on that in the coming months. No, I think that is kind of the direction of travel, right? Lots of focus of Iran demanding to be paid in either Remimbi or Stablecoin or crypto or whatever. So I think it's sort of this kind of chips away, continues to chip away at the dollar. I mean, we think de-dollarization is a multi-decade process. We've written about that kind of quite a lot. And I think this is just another but an important kind of chapter in that. And we'll have to, I think, trying to get data on this is quite hard. But we will look into this. And I think hopefully we'll put out a report in the next couple of months, kind of seeing what's happened so far and looking at the kind of the channels. I think one of the things everyone would want, I know, Europe to really promote the euro. They're trying to create, you know, exchanges or whatever to try and promote the use of the euro by pricing energy in euro. And they've really kind of struggled. So there's a lot of kind of intransigence to shifting away for the dollar. But probably events like this will chip away at the dollar long term. And maybe, Carson, a question for you here in terms of like central banks. So the question is, history tells us anything, is that central banks tend to underestimate price shocks. I suppose to sort of spin this another way, you know, are central banks going to react differently simply because they got it wrong four years ago? It's a very good question. I don't know whether I would fully agree, because if I look back, I think there was two, we also had one in 2012, which was a short lift and energy price shock. Back then also, I think central banks reacted maybe even too prematurely. So I think what is key for central banks in general, and that is, I think, the lesson from 2022 is, so not only what I mentioned, inflation expectations, et cetera, et cetera, but it's also the role fiscal policy plays in all of that. I think one lesson for central banks, and especially for the ECB in 2022 was that I think there were more than 500 individual government measures to somehow offset the energy price shock for companies and households. And that, of course, together with the post-lockdown era, and of course, they fueled this big inflation surge and the spreading of inflation. I think that is the lesson. If there is any lesson that the, especially the ECB will draw, it is following very closely what governments are doing. That's also why I think we hear quite some warnings from the ECB against too excessive fiscal support in the current situation to turn it around. If we were to see more fiscal stimulus coming in, whether it is price caps, whether it's direct support, whether it is implicit reduction of energy taxes. If we were to see any of those, then chances of more aggressive rate hikes are currently going up. Thanks a lot, Carsten. I think we're out of time. We've had lots of really interesting questions, but we will be writing a lot more about this over coming days. Carsten alluded to it. We're doing a monthly economic update next week with new numbers, new scenarios and everything. So do take a look at our think website, ing.com forward slash think over the coming days. Lots of good content coming out on this crisis. But all that leaves me to do is thank our speakers, Eva, Carsten, Chris and McKeel here in London. And thanks to you as well for joining us and hopefully see you again on our next webinar. Goodbye.