Rising Middle East tensions advance bond sell-off

US Brent crude fell 0.5 per cent to $US91.02 a barrel and West Texas Intermediate eased 0.4 per cent to $US88 a barrel. Oil prices retraced Wednesday’s gains after OPEC showed no signs of supporting Iran’s call for an oil embargo on Israel. Meanwhile, the United States plans to ease sanctions imposed upon Venezuela, releasing more production into the market.

Oil had its biggest weekly gain since February last week.

Fed chief in the spotlight

Reiterating a flashpoint among central bank officials, New York Fed president John Williams said rates will need to stay high for a while to get inflation back to the central bank’s 2 per cent target.

The attention is now turning to Fed chairman Jerome Powell who will speak on Thursday in New York. His views on interest rates will be challenged against the backdrop of a war in Ukraine and now the conflict in the Middle East.

“A key risk in the event of escalation would be the potential for an energy supply shock, which could underpin inflation and weigh on economic activity,” warned S&P Global Ratings.

“The risks of escalation involving the opening of a second front with full military engagement of Lebanese militant group Hezbollah remain material, but we think it less likely that Iran would become directly involved.”

Fed funds futures imply a 41 per cent chance of an increase this year, from 32 per cent last week, and pushed back the timing of the first easing to September 2024, from July.

Australian bonds rose in sympathy, with the three-year yield topping a three-month high of 4.24 per cent. The 10-year return reached 4.78 per cent, the highest since 2011.

Make or break

The Australian dollar fell 0.6 per cent to US63¢, a whisker from a one-year low of US62.83¢. It has shaved off nearly US5¢ this year, largely due to interest rate differentials between the US and Australia.

The local currency was knocked lower after a mixed jobs report. Australian employment in September gained 6700 in September, missing forecasts for a rise of 20,000, but the jobless rate surprisingly slipped to 3.6 per cent, from 3.7 per cent, in a sign the labour force remains tight.

“Today’s report is not the type of ‘red flag’ the Reserve Bank would need to see to justify a rate hike at the November policy meeting,” said David Bassanese, chief economist at Betashares. “That said, with house prices moving higher and upside risks to inflation from the rebound in oil prices, the November meeting is ‘live’ in the sense that there’s a non-negligible risk that RBA decides to raise rates.”

Next week’s quarterly inflation data could make or break the case for tightening.

“Our reading is that today’s figures suggest that the jobs market is not loosening quite fast enough,” said Paul Bloxham, chief economist Australia at HSBC. “If next week’s Q3 CPI figures also show that underlying inflation is not falling quite fast enough, we see a further 25 basis points hike in November as likely.”

Bond futures barely moved after the employment data, implying a 26 per cent chance of a RBA rate increase in November, from 30 per cent. They remain fully priced for a lift to 4.35 per cent by March with a small chance of a follow-up.