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Iran sanctions and spiking bond yields cause global turmoil

posted onMay 22, 2018

Despite all the euphoria in the past period about the world recovery, events have taken a sharp turn for the worse. Investors were spooked by Trump's decision to withdraw from the Iran nuclear deal, oil prices jumped to the highest level since 2014 and Italy moved toward forming a Eurosceptic-led government. 

The anti-establishment 5-Star Movement and the anti-migrant League identified Giuseppe Conte, a 53-year-old law professor with no political experience as their pick to become Italy's next premier.
The prospect of a 5-Star-League government has weighed on markets.

On Thursday, M5S head Luigi Di Maio and League leader Matteo Salvini agreed the basis for a governing programme that would cut taxes, increase welfare payments for the poor and scrap an unpopular pension reform.

Experts have estimated that the measures in the programme could cost over 100 billion euros while critics have said the programme does not give sufficient information about the financial coverage for these measures.

“With the M5S/LN government, the underlying problems of the Italian economy, including low growth, inflexible labor markets, inefficient banking system and public administration will not be tackled, in many cases only worsened,” Nordea Chief Strategist Jan von Gerich said in a note to clients according to Reuters. 

News of the Italian proposals caused concern also in Brussels, where Valdis Dombrovskis, a Latvian politician and the current European Commission Vice-President for the Euro and Social Dialogue, reiterated that the new Italian government will be expected to comply with the EU's budget rules.

 "I don't comment in the policies of parties or the processes of forming governments, but what I emphasize is that, in any case, it is important to abide by budget discipline and, especially for Italy, to continue reduce the deficit and debt because these are risk factors," Dombrovskis told the European Parliament on Thursday.

Italy, a founding member of the EU and the euro, is the third largest nation and the second modest indebted nation of the monetary union with debt of around 132 percent of GDP.

Oil prices soar on latest geopolitical turmoil

Geopolitical concerns that U.S. sanctions on Iran, one of the biggest oil producers in the Middle East, could curb the country's crude exports have led crude prices to trade higher in recent weeks.

Earlier this month, the International Energy Agency warned “The restoration of sanctions on Iran, which exports 2.5 million barrels of oil a day and is the world’s fifth-largest exporter, may have implications for the market balance.”

Brent crude, the international benchmark, topped $80 a barrel last week, trading at the highest since late 2014. Oil rose  63 cents to $79.85 a barrel by 0812 GMT today, supported by concern that falling Venezuelan crude output and a potential drop in Iranian exports could further tighten global supply.

The U.S. placed new sanctions on Venezuela following Sunday's re-election of President Nicolas Maduro, a move that analysts say could further curb the country's oil output already at its lowest in decades. 

Several banks have raised their oil price forecasts due to tighter supplies and a steady increase in demand. Morgan Stanley said it had raised its Brent price forecast to $90 per barrel by 2020.

"I think the whole 'lower for longer' thesis is probably dead for a while," Amrita Sen, chief oil analyst at Energy Aspects, told CNBC's "Squawk Box Europe" Tuesday. "We're looking at such a big potential disruption on the horizon … So the risk that you could lose such a big volume of crude oil exports from the market is what is keeping prices ticking higher," she added.

US bonds

U.S. interest rates have shot up to levels not seen in years recently

Key US 10-year bond yields are already at seven-year highs above three percent, in a signal that higher interest rates are ahead in the world’s biggest bond market, giving stock investors another concern. The 10-year Treasury rate is especially important given its role in helping set interest rates for a whole range of business and consumer loans, including home mortgages. 

The10-year Treasury note, a crucial benchmark for global markets, had a yield of 3.07 percent on Monday and has risen about 71 basis points for the year through Friday as investors fear the Federal Reserve could tighten monetary policy faster than expected.

Jon Day, a global bond portfolio manager from Newton Investment Management told The Financial Times he worries that bond yields could rise to levels where “servicing costs become an issue”, which could slow economic growth. 

According to a Bank of America Merrill Lynch global fund manager survey published last week, only a net 1 per cent of investors believed the world economy will strengthen in the next 12 months, while just a net 10 per cent of respondents believed corporate profits will improve, the lowest proportions since 2016. The years of relative calm on the stock markets have come to an end. Prepare for storms ahead.

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