Peace deal sees markets rally, oil and dollar lower
The evolving situation in the Middle East sees a peace deal between the US and Iran and the Straits of Hormuz reopen. President Trump, last night, said the deal was ‘complete’ and that it will be signed in Switzerland next week. No text has been released and, once it is signed, the waterway will reopen and also the US and Iran will have further talks on resolving outstanding issues including sanctions on Iran. Oil and gas prices fell further on the news, having declined already late last week when news that this deal was close broke. A barrel of Brent fell to $83, the lowest since the opening days of the Iran war, while WTI fell to $80. The dollar also slid, with the euro getting back to above $1.16, for the first time since the strong US payrolls data two weeks ago, and sterling rose to $1.3440. The euro and sterling remain locked in a tight trading range, having been trading around 86.3p since the start of the month and continuing to trade around that level today. There could be further positivity today from this peace deal, but there are still threats to the deal, not least from Israeli strikes in Lebanon over the weekend, which the US has asked them to stop. Further out it seems the most difficult areas to agree have been left to the next stages of talks which could mean more volatility during those negotiations.
Euro bonds rallied further on Friday. The ECB rate hike on Thursday did not send bond yields higher and, in fact, the positive news from Iran has seen rates fall. Should this deal hold and energy prices and inflation ease, therefore reducing the pressure on central banks to raise rates. Euro area bonds rallied across the curve, with 2-year, 5-year and 10-year yields all falling in most euro area member states. 10-year bund yields are down 8bps since last Wednesday and are now below 3%. UK 10-year yields are down 10bps since Wednesday and US 10-year yields are also down 7bps. Yields are ticking down again on the open this morning. The positive sentiment also saw broad-based gains in equities, with the S&P up 0.5% on Friday and the Eurostoxx up over 2% on Friday, making up for missing the rally in US stocks on Thursday when news of the possibility of a peace deal broke after the European close. Overnight last night, after news of the Iran deal, the Japanese Nikkei index gained almost another 5% following a near 3% gain on Friday.
The University of Michigan US consumer sentiment index came in at 48.9 in June, above the consensus, and rebounding from a record low of 44.8 in May. While a welcome upward move, the first in four months, the index remains at a historically low level and the report noted that views on the economy remain ‘dour’ and consumers were focused on ‘kitchen table issues’ like the cost of living. The rebound appeared to be driven by easing in the pace of gasoline prices in June, so the news of the Iran deal, which should lower gas prices, should boost consumer confidence next month. While cost of living remains a key concern, 1-year ahead and 5–10 year-ahead inflation expectations both fell, which suggests inflation expectations remain anchored, a positive for policymakers at the Fed.
The Bundesbank published its latest set of forecasts for Europe’s largest economy. Not unexpectedly, the Bank cut the growth outlook for Germany while raising the inflation outlook when compared to its last forecasts in December. GDP growth in 2026 is now expected to be just 0.5% before rebounding to 0.8% next year, with growth expected to stagnate in Q2 of this year before growing only slightly in Q3 and onwards. The economic recovery, which began last year supported by fiscal stimulus, is expected to be weighed down by reductions in household spending power due to rising inflation.
There were several ECB speakers out on Friday following the ECB decision on Thursday to raise rates. Nagel from the Bundesbank said the ECB stood ready to hike again in July if necessary, but future decisions would be data-driven. Moulin from the Bank of France said that the energy shock will be persistent regardless of any short-term developments and the ECB, while not committed to any rate path, was determined to bring inflation back to 2%, while Makhlouf from the Central Bank of Ireland said he was seeing more broad-based inflation impacts and the ECB needs to get ahead of inflation. While this was all quite hawkish talk, the chances of a July hike have receded, again, due to the Iranian peace deal. The market was pricing a 60% chance on Thursday but only a 15% chance today, with a September hike now not fully priced in either and a fresh 25bps hike pushed out further into Q4.
On the agenda this week, aside from the seeming end to the US/Iran war the focus will be on central bank decisions and any guidance thereafter. The FOMC meeting and rate decision will be on Wednesday and new Chair Warsh’s maiden press conference will be closely watched, in light of the evolving situation in Iran, alongside updated materials including a new dot plot. There is no chance of a change in rates, with the market currently pricing in the next move, a 25bps hike, next March. Similarly, the Bank of England MPC will announce their decision on Thursday, but again, while the event will be closely watched, there is no chance of a change in policy, with the market not pricing in a UK hike until December.