US Rates Strategy: Market clears data hurdle, but geopolitical risks loom large

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US Rates Strategy: Market clears data hurdle, but geopolitical risks loom large

Figure 2: While market-implied July hiking odds have Figure 3: ...and yields across the curve remain elevated

fallen sharply, markets continue to price roughly 40bp of relative to our fair value framework, although within the

tightening by April... standard error of the model

air value framework, although within the standard

y, markets continue to price roughly 40bp of tightening by April.

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mplied July hiking odds have f allen sharpl ross t he cur ve rem ain el evated relat ive to our fSource: Bloomberg, UBS Source:Bloomberg, UBS [Note: For model details, see here.]

That said, geopolitical uncertainty is the main near-term risk to this view.

Ceasefire negotiations with Iran have fully broken down, with US strikes continuing for

seven consecutive days, and with targets broadening from Iranian military sites to civilian

infrastructure. Brent oil prices have risen 16% on the week, to $88/bbl. A further

escalation in the near term remains likely, and oil flows through the Strait of Hormuz

have already slumped since fighting resumed last week. With the Fed firmly focused on

the inflation side of its dual mandate, a continued rise in oil prices would keep the

possibility of hikes in play. Against this backdrop, we continue to prefer trade

exposures that are better protected against energy-price risks than outright

long duration positions at the front end. Over the near term, the data calendar is

relatively quiet next week and the FOMC enters blackout ahead of its July 28-29

meeting, so focus is likely to remain on geopolitical developments in the Middle East for

now. We recommend holding longs in 3Yx4Y swaps and in 5-year real yields (see

here).