ING strategist Michiel Tukker stresses that current Oil volatility is feeding directly into rate expectations for the European Central Bank (ECB), Federal Reserve (Fed) and Bank of England (BoE). He explains that a $10 move in Oil can quickly shift implied hikes by about 25bp, distorting short-end pricing, widening bid-ask spreads and reducing liquidity as geopolitical headlines hit markets.

Oil volatility distorts rate pricing

"The ECB is clearly not set on raising policy rates this April already, but market expectations remain high for a hike in June. Currently, a full 25bp of hikes is priced in by June and at least one more hike by the end of this year."

"Much will depend on the oil price, however, because for every $10 increase in the oil price, the market’s hiking expectations increase by roughly 25bp."

"Similarly for the Fed, and especially the Bank of England, the correlation between policy expectations and oil prices remains very tight."

"With current volatility in oil markets, a $10 move can materialise in just one day."

"The volatility in short-end rates makes it difficult for market players to take positions, potentially distorting the relationship between actual expectations and market pricing."

"Even if an investor has a high conviction view of a central bank’s reaction function, taking a position is risky, as a single geopolitical headline can trigger a sharp jump in the wrong direction."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)