[MARKET ANALYSIS] USTs initially gapped higher, before waning as traders assess the inflationary impacts of the US/Israel-Iran war

• Global fixed benchmarks were initially bid at the open, before gradually waning off best levels throughout the APAC session. As the European session got underway, price action has more or less been sideways; USTs and Bunds lower by a handful of ticks, whilst Gilts underperform. The initial bid due to geopolitics. In brief, the US-Israeli war with Iran has entered its third day, with all sides conducting large-scale airstrikes. Airspaces have been closed, oil refineries and tankers have been hit, and threats of further attacks continue (see "Iran Situation Report - Day 3" on the headline feed for more detailed analysis).
• USTs opened higher, then jumped to a session high of 114-12, before quickly paring much of the upside as the APAC session progressed. The narrative quickly shifted from “haven” related upside, to traders assessing and then pricing in the inflationary impacts of the closure of the Strait of Hormuz. This impacts both; a) energy prices, b) prices of goods which are subject to longer trading routes, as shipping giants avoid the chokepoint. From a central banking perspective, inflationary pressures could see policymakers shift hawkishly – though, Danske Bank suggested that the Fed is unlikely to trigger speculations of near-term policy shifts following the rise in energy prices. Geopols aside, the US ISM manufacturing survey for February is expected to be little changed at 52.3 (from 52.6). The Atlanta Fed will update its GDPnow tracking estimate, which is currently modelling growth of 3.0% in Q1. In later trade, the Fed will publish its Senior Loan Officer Survey. USTs currently trade around 113-23 within a 113-22+ to 114-12 range.
• Bunds moving in-line with peers and currently trading around 130.05 to 130.53 range. Price action is similar to the above, initial haven flows buoyed German paper, before markets began factoring in inflationary impacts. Danske expect short-term widening Schatz spreads, but the bank highlights that safe-haven inflows are often short-lived and modest.
• Gilts are underperforming, and trades lower by around 30 ticks within a 93.31 to 93.57 range. Underperformance which perhaps can be explained given that the region is a net-imported of oil, and as such has long been considered highly vulnerable to energy volatility. Elsewhere, ahead of this week’s UK Spring Statement, Chancellor Reeves has received a GBP 22bln windfall as tax receipts outperformed forecasts, according to Bloomberg; analysis of official data showed stronger than expected self-assessed income tax and sales levy revenues, alongside lower debt-interest spending, contributing to the improvement in the public finances.

The early bid in USTs driven by geopolitical tensions related to the Israel-Iran conflict reflects a flight to safety amidst rising uncertainties. However, as traders start to evaluate the inflationary implications of disrupted oil supplies, particularly through the Strait of Hormuz, there is a notable shift in sentiment that could impact central bank policy, although immediate rate changes from the Fed are considered unlikely. This dynamic feeds into broader markets, as the potential spike in energy prices could affect risk sentiment across various asset classes.