Tech Weighing on Indexes

MACRO FRAME

Global equity markets appear to be treating US-Iran talks to reopen the Strait of Hormuz as a done deal, leaving Friday’s labor report as the key risk event in its potential Fed policy implications.

STOCK INDEX FUTURES

Equity index futures were mixed in overnight trade; the Nasdaq is leading losses down over 1%, as tech sentiment was weighed down after chip maker Broadcom failed to meet revenue expectations in its quarterly earnings report. Other related stocks fell in suit as well. Still, tech remains the catalyst for the strong rally in the equities in recent weeks and has been responsible for all of the S&P’s gains over the last three months. Excluding the tech sector from the S&P, it is below its level from three months ago. Meanwhile, blue chip stocks are benefiting from the drop in oil prices overnight, as evidenced by the rise in the Dow. Israel and Lebanon agreed to renew their ceasefire, which has raised hopes that the US and Iran can agree to a deal. ISM’s services PMI data showed the strongest expansion of services activity in three months, reversing April’s pullback and suggesting that underlying services demand conditions remain firm. The index rose to 54.5, above forecasts, while New Orders rose to 57.3, Business Activity rose to 57.7, and Inventories surged to 62.5, reflecting a combination of stock-building general demand. The report also revealed that price pressures remain a headwind for business, with the Prices Paid index rising to 71.3, its highest level since August 2022. Monday’s ISM manufacturing PMI data showed the strongest expansion of factory activity since 2022, with new orders, production, order backlogs all rising substantially, while customer inventories remained low, positive signs of demand and future production. This week’s big event is May’s nonfarm payrolls report due tomorrow; another strong report like April’s would reinforce the view that rate cuts are unlikely in the near term, especially if it shows robust wage gains.

Watch point: Details regarding tanker traffic through the Strait will be a catalyst for global markets and may significantly reprice expectations over Fed policy, though negotiations are likely to need further time.

FOREIGN EXCHANGE

US DOLLAR: The USD index moved lower alongside the drop in oil prices overnight following the news that Israel and Lebanon had agreed to renew their ceasefire, which has raised hopes that a US-Iran deal will happen. The dollar index is down 0.34% to 99.19, falling back into the 99.00-99.30 range is has maintained since mid-May. Several counter-acting forces are at play, largely being the inflationary backdrop and resulting Fed expectations alongside risk-on flows away from the dollar as expectations of an extended ceasefire grow. A Reuters poll on Wednesday showed that FX strategists expect the dollar to remain range-bound in the near term before ultimately weakening later in the year. Since the conflict began, the dollar has been a gauge for broad risk sentiment. The main driver of dollar weakness remains risk-on flows in the face of market optimism over an end to the conflict in the Middle East, which markets expect would drop a growing hawkish bias from the Fed. However, pass-through effects from supply chain disruptions and the rise in energy prices are likely to make it difficult for the  Fed to lower rates over the next two quarters even if the Strait was reopened today.

Watch point: Currency markets are in wait-and-see mode ahead of Friday’s labor report and any further developments between the US and Iran.

EURO: The euro is 0.41% higher at $1.1641 following the rise in risk sentiment overnight. With no new data overnight attention will center around US-Iran developments and tomorrows GDP and US labor data. The euro is likely to trade opposite oil prices. Inflation data on Tuesday reinforced the case for policy tightening at the European Central Bank’s June meeting later this month, with headline inflation rising to 3.2% YoY, while core inflation rose to 2.5% YoY. Positively, for the ECB, services inflation eased, the only major component to move downwards. Given that services represent nearly 47% of the inflation basket, the central bank should find some relief regarding the overall inflation narrative. The ECB maintains the scope to tighten policy without worrying about impacts to economic growth, though the extent to which policy tightening is necessary may be limited to just one rate hike if the Strait is reopened within the month and if services inflation does not pick up. Money markets maintain 98% chance of a hike at the June meeting and see 63 bps of tightening by year-end. For the euro, broader risk sentiment will continue to determine price direction, while the interest rate differential against the dollar remains unfavorable given the recent shift in Fed expectations.

Watch point: While a June rate hike is expected from the ECB, a peace deal and restoration of oil flows through the Strait is likely to reduce tightening expectations.

BRITISH POUND: Sterling rose 0.33% to $1.3459. Despite a dovish repricing of Bank of England expectations, the sterling has gained as a result of the reduction in geopolitical risk and decline in demand for the dollar. While a peace deal would see the pound strengthen on the back of risk-on flows, that would also open the door for a resumption of policy-easing from the BoE later in the year and lend focus back to the economic and political challenges, which were initially pressuring the currency. A fully priced rate-hike has been priced out to September, while a second rate hike is expected in March 2027.

Bank of England Governor Andrew Bailey has suggested that the Bank of England has no immediate desire to move on policy, as Bailey said that allowing inflation to run above the BoE’s 2% target was justified given uncertainty over the economic impact of the Iran war and the weak pace of growth. Political risks still pose as a potential downside risk for the pound despite having eased in recent weeks. Mid-June’s Makerfield by-election remains a potential catalyst that could renew discussions over fiscal policy and see Starmer’s leadership challenged.

JAPANESE YEN: The yen is little changed at 159.82 yen per dollar, continuing to find resistance near the 160 level. Prime Minister Takaichi’s verbal intervention warning offered the yen support on Wednesday, while Bank of Japan Governor Ueda said the Bank of Japan needs to discuss the pros and cons of raising rates. Recently Ueda has had a string of hawkish comments, which has suggested that that policy rate has further room to move upwards. Money markets continue to expect a rate hike come June, pricing a 80% chance of a hike, up from 70% on Tuesday. The market sees a total of 44 bps of tightening by year-end. Intervention risk continues to offer the currency support near the 160 level.

AUSTRALIAN DOLLAR: The Aussie is 0.18% higher at $0.7142 as the rise in risk sentiment overnight supported the currency. Trade data for April showed Australia logged a near $1.8b trade surplus in the month, above forecasts of $1.2b. Q1 GDP rose by 0.5%, while annual growth held at 2.5%, the figures were in line with forecast. Largely, demand is still outpacing supply, labor conditions remain tight, leaving inflation conditions pointed upwards. While the RBA has broadly signaled that it is in a wait-and-see mode following three rate hikes earlier this year, markets are still expecting one more rate hike by the end of the year. Trimmed mean measure inflation sits at an annual pace of 3.4%, which is likely to reinforce a tightening bias from the RBA. Markets have slashed tightening expectations in the near term, implying a 7% chance of a June hike to the 4.60% cash rate, while a December hike is priced at 67%.

TREASURY FUTURES

Yields moved lower across the curve as oil prices fell, while Q1 productivity and labor cost figures came in below expectations, supporting buying conditions. Tomorrow’s labor data remains the main watch item aside from US-Iran developments. While JOLTS data revealed that job openings rose +731,000 to 7.618 million in April, the surge was driven by a 668,000 rise in openings in professional and business services sector, which tends to find volatile revisions in later data. Meanwhile, hires fell -419,000 to 5.1 million, the second-largest monthly decline since July 2020, pushing the hire rate down 30bps to 3.2%. This “openings up, hiring down” dynamic suggests companies are posting positions but remaining cautious about actually filling them, consistent with elevated uncertainty amid the conflict and raising the risk of a below-consensus reading for May payrolls figure. With recent data suggesting a stable labor market, Friday’s data will need to see a serious drop in hiring to get the market excited about rate cuts this year.  The Chicago Fed’s Real-Time Unemployment Rate Forecast for May is 4.32%, edging down from the prior BLS reading of 4.34%. The modest improvement is largely attributable to a slight decline in separations, as reflected in the Chicago Fed’s Layoffs and Other Separations Rate. Treasury markets continue to take directional cues from oil prices, as a sustained move higher in crude would carry the greatest risk of re-anchoring embedded inflation expectations at elevated levels. The 10-year yield has tracked the trajectory of December Brent crude closely over recent months, though there are emerging signs that this correlation is beginning to soften.

Watch point: The path to loosening has appears nonexistent as inflation has evidently become more broad based. We no longer expect the Fed to lower rates in 2026 as building inflationary pressures are evident in stickier readings.

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