Hope for durable Middle East peace agreement sees global risk-on rally
Monday was dominated by the news of the interim US/Iran peace deal, which kicks off 60 days of further negotiations on a more comprehensive and durable agreement, but the Straits of Hormuz could be open to traffic by the end of this week – though there is reports of some disagreements between the US and European allies about the practicalities of that timeline as the Straits will have to cleared of mines and patrolled. The news set off a broad global risk-on rally, with equities shifting higher, bond yields dipping and oil prices shooting down. The euro opened yesterday, sharply higher against the dollar at over $1.16, getting up to $1.1620 at times, but lost a little ground during the day and is down to around $1.1590 now. It was similar for sterling, which got up above $1.3450 at times yesterday but is off a little now, at close to $1.34. Very little is shifting the euro/sterling cross, which ticked up marginally yesterday to 86.5p but is once again at 86.4p this morning. The Iran news sent wholesale energy prices globally sharply lower. A barrel of Brent opened at under $85 and has weakened further to under $83 now, about 25% lower than its peak during the conflict, though still up about $20 per barrel on prevailing prices before the war started.
Bonds rally further as markets reduce chances of interest rate hikes. With the outlook now changing, there were further falls in yields in Europe and the US. 10-year bund yields were down another 4bps yesterday to 2.95%, and down about 13bps since last Wednesday. 2-year bunds were down 5bps to 2.57%. 10-year UK yields were down 6bps to 4.17% and 10-year US yields shaved off 3bps to 4.05%. Markets are repricing rapidly the interest rate path for the major central banks as inflation pressures from higher oil prices now start to ease. The market had thought the ECB would hike in September, but that is now pushed out to October (and at times yesterday pricing was pushing that hike into December). The next Fed move, still a hike, is not seen until March of next year now, while the Bank of England hiking cycle is now not expected to start until November/December of this year. All those central banks are now priced for just one hike from this point, with the chances of a further hike for any of them in the first half of next year at best 50/50 currently. Overnight the Bank of Japan raised rates by 25bps taking the benchmark rate to 1% for the first time since 1995 and the BoJ signaled a steadying of policy with the market not fully pricing in another hike from them this year.
In equity markets, there was a further risk-on rally for most indices, particularly in the US, with the S&P up 1.7%, and back to about 0.5% off its record high. The NASDAQ was up 3% and the Dow up 0.9%. The gains were smaller in Europe, with the Eurostoxx up 0.7%, though that index has now taken back all its losses since the start of the US/Iran war and is back to a record high. The FTSE lost ground, down 0.4% for the day, but that was due to poor sentiment around its energy and defence companies, which weighed on the index.
All quiet from Bank of England and Fed speakers ahead of the meetings this week, but we did get more commentary from the ECB. Despite the good news from the Middle East and the likelihood of more subdued energy prices, the ECB will still be concerned about the damage that has been done already by the energy price shock. President Lagarde said yesterday that second-round inflation effects have ‘absolutely started’ to emerge and that the ECB would ‘necessarily have to take measures’ if they persist. Nagel said the ECB is still ‘broadly neutral’ despite last week’s hike and that while they are no longer dealing with a short-term supply shock, they ‘cannot exclude second-round effects’ and would keep all options open for the July meeting.
US industrial production fell 0.1% in May and the Empire manufacturing sentiment index fell to 5.7 in June from 19.6 in May. Production appears to have stalled in May, with a sharp drop in chemicals and petroleum products masking a solid durable goods increase, particularly goods related to the current boom in AI data centre outfitting. The weakness in chemicals and petroleum is probably linked to supply chain disruption from the war in the Middle East, so yesterday’s peace deal should, hopefully, get supply chains back to normal in the coming months. Similarly, the fall in the Empire index was due to concerns over cost pressures from higher energy costs from the conflict, which should now, hopefully, ease.
In China, key data released overnight was poor, consumer and investment numbers dipped with retail sales in May down 0.6% year-on-year and year-to-date investment down 4.1%. House prices also fell in May. While there are signs of slower growth on the domestic side of the economy, exports and tech industries are doing well, led by AI, with industrial production up 4.5% year-on-year in May. The data shows the broader Chinese economy is somewhat imbalanced and led by exports and factors outside of China’s control while domestic demand is weak. The data today showing the economy may be growing at close to 4% currently, below the Government’s official target of 4.5% to 5%.
On the agenda today, we get German ZEW confidence data, Euro Area labour costs, and the ADP weekly employment change and monthly housing starts from the US. ECB speakers include Chief Economist Lane, Escriva and Sleijpen.