As conflict in the Middle East intensifies, supply shocks and central bank policy decisions are fuelling heightened volatility—particularly in global rates markets. Speaking to Trader TV, Laura Cooper, global investment strategist at Nuveen, highlights sharp repricing across rates, especially in UK government bonds, and shifting expectations for interest rate moves this year. She also examines Europe’s relative exposure to inflationary risk compared with the US; liquidity conditions across emerging markets, and how her team is leveraging real-time and alternative data to guide investment decisions and assess potential turning points in the conflict.
Interview
Josephine Gallagher – It’s always good to start off with some context, so given the ongoing crisis and conflict in the Middle East, and the market volatility. Tell us what you’re seeing in terms of activity in the rates market?
Laura Cooper – Well, market moves have been predominantly dictated by central banks’ rate decisions. We had a busy calendar last week as policymakers try to navigate through this geopolitical-led supply shock. And so I think really that the market repricing that we have seen has been the most interesting, and even just markets attention to the inflationary impulse of the shock at the expense of looking at the potential drag on growth. And so this has certainly been exacerbated by central bank’s rhetoric more recently, we have seen that sharp sell-off in front-end rates. From a most interesting perspective, I certainly think it’s the front end of the UK Gilts curve. The UK entered this shock with a weaker labour market. We did see policy rates already in restrictive territory, and yet the Bank of England surprised by having a hawkish guidance for the potential for rate hikes to be their next move. And so, from a market’s perspective, we’ve gone from pricing in around two cuts this year. Now, those aggressive long positions were sharply unwound. Markets are looking at anywhere from 2.5 rate hikes this year. So markets were already nervous heading into that UK decision, and I think the sell-off that we are seeing in these UK Gilts markets really is probably where the greatest mispricing is right now. And then, maybe briefly, two other interesting moves that I think we have seen, certainly in EM, the speed at which some of those popular fast money trades have come off during the early stages of the conflict, I would say, has been most surprising, particularly looking at Hungary, Turkey local rates, even Ukraine, was a popular trade to start the year that is now just about 10 points off the wides. And then broadly in investment grade credit across both Europe and the US, just the degree of resilience that we have seen in this market, despite the shock and I think it raises the question of, well, how much complacency is there in these markets if we were to see more of a persistent shock materialize?
Josephine Gallagher – So Europe is more likely to be hit quicker than the US in terms of inflation shocks as well as knock-on risks. How does that play into your market analysis and how you protect your portfolios?
Laura Cooper – So Europe is more exposed on several fronts, which is actively informing how we are managing risk. I think if we take a step back and look at the US, the US is more insulated. The US is a net energy exporter. They also have a weaker labour market as a starting point, and so that essentially kind of curtails the capacity of the Fed to tighten into this shock. Whereas in Europe, we are seeing ECB ( the European Central Bank) be in a better position to potentially tighten rates. They have a relatively benign inflation backdrop. The policy rates are broadly neutral, and they did echo that as much last week. But I still think there is this negative growth impulse that markets need to pay attention to if we do see more of a persistent shock materialize. That does suggest maybe the pricing for the ECB right now, upwards of almost three cuts, is still quite aggressive. If we think about the natural gas imports to Europe from the Middle East, there are about 5% of total natural gas imports to Europe. And if we were to see, let’s say, a critical threshold of 10 weeks of those supply disruptions persisting, then that would potentially tilt European natural gas prices above those 2022, peaks. So that’s why we are seeing policymakers react the way they are, but that does have quite a significant growth impact, as well shaving off as much as half a percentage point to growth. So in terms of managing our portfolios in this backdrop, it’s about having that modest underweight to European rates, not adding aggressively to European credit, and then as well, taking more of that up in quality posture. And maybe just a final point to add around this, in contrast to that 2022 shock, the Russia-Ukraine invasion, where we did see natural gas as that primary transmission channel to the European economy, this time, crude oil is globally priced, so we suspect we’re going to see that inflationary impact more broadly distributed and not particularly concentrated in Europe like we saw back then.
Josephine Gallagher – Now turning to emerging markets, how are they performing, how has liquidity held up, and are you seeing any risks to rising default rates?
Laura Cooper – So emerging markets have experienced significant volatility, but much of what we have observed really reflects more positioning unwinds, rather than a deterioration in broader fundamentals. I think heading into the conflict, EM assets were heavily owned, and the initial market reaction did trigger stop outs and deleveraging that just exacerbated the moves. Particularly, I would say in EM FX as a lot of this kind of sharp sell-offs that we did see were in those currencies that were heavily owned entering into the conflict. In terms of EM spreads, they have widened, but they do remain relatively tight from that historical context, and they’re not really pricing in a meaningful stagflation risk or some of those tail risk escalation scenarios. I think to your point around liquidity, yes, it’s held up, though it is thinner than normal. I think market participants have broadly scaled back positioning, and they’re just waiting for greater clarity to re-engage in some of these trades. We are beginning to see selective opportunities in those markets where we have seen aggressive repricing. So Brazil, Colombia, some of those CEE (Central Eastern European) countries as well, although I think kind of taking a step back and all that said, we’re not rushing to deploy broadly. But I think instead reducing FX exposure remains prudent, maintaining a more cautious stance until we have greater clarity on how this conflict unfolds. And the key distinction, I think, is really just being able to discern where spreads have kind of repriced and are creating genuine value with sufficient carry cushion, versus those where we think spreads are not accurately compensating for the risk still embedded in this broader macro backdrop.
Josephine Gallagher – So obviously, this is a very quickly evolving situation, could you tell me, how is your team using real time and alternative data sets to try and inform your investment decisions?
Laura Cooper – It’s a great question, because given the fluidity of the current situation, what we are seeing is that traditional macroeconomic indicators that typical market participants would focus on are often lagged in this type of environment, and instead, we are seeing geopolitical developments really drive some of that price action. So we have therefore been leaning on a range of real-time variables to assess the potential market trajectory from here. I would say the most crucial indicator that we have been watching is the Strait of Hormuz flow data, and that’s tracking the volume, the frequency and the type of vessels moving through the Strait. Because in order to have a sustained normalization in oil prices, we really need to see a more sustained reopening of this, this Strait of Hormuz. Alongside this, we’re watching drone missile strikes. Not just the frequency, but the accuracy and the targeting patterns, because this can give an indication of whether we are seeing a material escalation or deescalation come through on this front And on the energy side, I think it’s crucial to monitor the oil futures curve and even spot brent prices, because that dictates to us that we are in an exceptionally tight oil market, yet markets are still pricing in a near term shock that could fade over the coming months, and as we start to see more indicators of the tightness persisting, then that does lend itself to even greater volatility across markets. And then finally, I think it’s important to maybe watch for shipping insurance data and tanking routing patterns, that provides a real-time read on how the commercial industry is assessing risks as well, which could provide an indication of whether we will start to see more meaningful flows through that crucial Strait of Hormuz.
Josephine Gallagher – And finally, Laura, what else have we not discussed in this conversation? What else is top of mind for you this week?
Laura Cooper – Well, the current environment is, strikes me as one that we’re in kind of headline-chasing market dynamic, and so that does suggest that geopolitical developments will continue to drive price action. But as well, importantly, given the week that we had last week of central bank rate decisions, we’ll be watching for policymakers rhetoric this week, whether we do see them kind of paring back some of that hawkish guidance, predominantly if we think about the Bank of England, but as well the European Central Bank in some commentary that is expected in the week ahead. We also have important data coming through in Europe in terms of those March PMI (Purchasing Managers Index) flash gauges, will we start to see signs of any economic deterioration as a result of this geopolitical shock materialize that could then kind of thwart some of this European recovery story that has really been consensus through most of this year. And then finally, just looking at kind of private credit markets, I think that has been simmering in the background. Certainly are overtaken by the geopolitical headlines. But if we start to see this kind of persistent oil volatility, this policy uncertainty, kind of elevated market uncertainty overlaid with the risk that central banks could actually enter tightening cycles that could certainly exacerbate some of the moves that we have seen there, and perhaps have a more durable impact on growth than just the oil supply shock alone.
Catch Trader TV shows each week:
To watch Trader TV This Week shows go to – Video
Or make sure to follow us on LinkedIn – Trader TV’s LinkedIn
Available as a podcast – Link
