TACO Questioned Amid Middle East De-escalation Efforts

In focus today

In the euro area, the March flash PMIs are released, which is the first growth indicator following the war in Iran. The manufacturing sector is expected to record a large decline to 49.6 from 50.8 as higher energy costs have likely lowered some production in March. The services sector is less directly affected by the energy increases in the short term, so we expect a smaller decline here to 51.1 from 51.9, thereby keeping the sector in growth territory.

From the US and UK, we also get flash March PMIs, which will shed further light on how rising oil prices are affecting global economic activity. Both countries are expected to report declines but remain in growth territory. Recent PMI data from the UK pointed to stronger economic momentum in Q1, while US data showed manufacturing slowing amid weaker output, prices and new orders.

In Hungary, the central bank is set to announce its Base Rate decision. We expect the rate to hold steady at 6.25%, aligning with consensus expectations.

Economic and market news

What happened overnight

In Japan, data has come in on the soft side, with composite PMI at 52.5 down from 53.9, driven by both manufacturing and service. CPI inflation, excluding fresh food, declined to 1.6% in February from 2.0%, marking the first time below the inflation target in four years. Fuel subsidies is a key driver, and the reality has changed a lot since February as PMIs reveal a marked increase in firms’ input prices and the yen remains under pressure. We expect the next BoJ hike in April. Markets are pricing close to 50-50 for that.

In EU-Australia relations, a significant trade agreement has been finalised. The deal eliminates tariffs on nearly all European goods and Australian critical minerals, while introducing quotas for certain Australian agricultural exports such as beef and sheep meat. The removal of import tariffs on Australian critical minerals into the EU is expected to support the stabilisation of global supply chains.

What happened yesterday

The Middle East conflict triggered a shift in markets yesterday as the US announced a five-day pause in attacks on Iranian energy infrastructure amid reports of ongoing talks to end the conflict. Iran dismissed the claims as “fake news” but confirmed efforts to de-escalate tensions, while reports suggest direct negotiations may occur in Islamabad this week. Israel confirmed discussions to secure a deal addressing the war’s objectives and “protecting vital interests,” while a European official noted Egypt, Pakistan, and Gulf states are relaying messages between the US and Iran.

Markets saw relief from Trump’s announcement, briefly sending Brent crude below USD 100/bbl, though prices remain elevated compared to pre-war levels. While easing tensions could drive prices lower, risks of a rebound persist as WSJ reports Saudi Arabia and the UAE are pushing US to continue to fight and are mulling joining the war.

In the US, Fed Governor Miran (voter) emphasised the need to wait for more data before adjusting the policy outlook. He maintained his stance on gradual interest rate cuts, revising his forecast from six to four cuts this year while raising his inflation outlook. This morning, we adjusted our Fed call slightly and now call for the final two rate cuts only in September and December this year (prev. June and September). Read more in Reading the Markets USD – War delays rate cuts, 24 March.

In the euro area, consumer confidence fell more than expected to -16.3 in March (cons: -14.2, prior: -12.2). Consumer confidence thus reached the lowest level since October 2023. Consumers are likely to be more cautious with spending due to the decline in confidence, which highlights the negative growth consequences of the war in Iran. The survey period is “generally the first two to three weeks of the month” according to Eurostat, so the effect of the war is captured, but as energy prices have continued to rise during the month the full effect is likely not captured yet.

Equities: Equities rebounded in a rare manner following a post from the US president that negotiations have been initiated and a five-day long halt to attacks will follow. European equities that were down south of -2.5% on Monday, rebounded 4.5% from low to high. The gains later faded, as Iranian officials denied that negotiations have been held. Nonetheless, equities closed higher with S&P 500 up 1.2%, small cap Russell 2000 up 2.3% and Stoxx 600 0.6%. Futures have however dipped back into negative this morning.

The sector preference was mostly reversal of geopolitical trades. Cyclicals led the gains, and primarily growth cyclicals as yields dropped, including tech and consumer discretionary in the lead. What is just as interesting is to see which sectors that did not rebound on the news. The real estate sector, one of the worst performers the last week, did not benefit from the drop in yields, but continued to underperform. Similarily, consumer staples that, believe it or now, have sold off more than industrials over the last month did not rebound either. To us, this is a sign that investors priced out some of the recession risk yesterday through the cyclicals, but that inflation and rate hike expectations are little changed. This can serve as a guide on what a TACO trade would like ahead.

FI and FX: It was quite the rollercoaster ride for market yesterday. From a tense opening, where oil prices were on the rise pushing the USD and yields higher to a sudden relief rally after US postponed attacks on Iranian energy installations citing productive talks to renewed rise in tensions as WSJ reports Saudi Arabia and UAE are pushing for the fight to continue. What was most striking yesterday was the development in EUR/NOK. The pair moved sharply higher in the morning – a move that did not reverse in the relief rally. The correlation to moves in energy prices has turned as risk assets have started to price a growing risk of recession should central banks tighten monetary policy on top of the energy supply shock.