Busy Week for Markets

MACRO FRAME

The pause in military exchanges between the US and Iran could lead to more action on the diplomatic front, though the geopolitical risk premium in energy continues to support a hawkish macro backdrop.

STOCK INDEX FUTURES

Equity index futures were higher overnight, as the markets welcomed a pause in fighting between the US and Iran. Trump has halted the bombing campaign on Iran, following military advice that the US was running out of meaningful targets and depleting air‑defense munitions. Iran has said it will suspend its own attacks as long as the US pause holds, but explicitly denies “requesting” negotiations, saying renewed talks with Washington are “not in our DNA” even as messages continue via mediators. As for the geopolitical risk premium, the pause cannot necessarily be seen as broad deescalation, but a deescalation nonetheless. Iran continues to insist it maintains control over the Strait. Iranian sources reiterate that only the Iran‑specified channel, hugging its coast, is considered valid. The tech sector is getting a boost from the increase in risk sentiment and news that Nvidia is in talks to provide roughly $250 billion in financing guarantees for OpenAI as part of a data center project, per the Wall Street Journal. Last week, volatility in the tech sector was driven by results from Alphabet and Tesla in regard to their massive AI spending plans. Microsoft, Amazon, and Meta will all report this week. Focus is likely to continue to center around capex plans and corresponding returns. The AI-capex reaction function is driven by two factors. 1: demand for visible returns and free cash flow discipline. Investors are increasingly insisting that massive AI capex be matched by clear revenue and profit growth, not just “technology promise.” 2: skepticism about overinvestment and valuation risk. AI spending plans are likely to remain under the microscope and determine at-large sentiment for tech as investors assess whether AI infrastructure is producing meaningful returns, and whether profit growth can or will justify elevated valuations.

CURRENCIES

US DOLLAR: The USD index fell overnight to 101.38 as a pause in fighting between the US and Iran and a corresponding drop in oil prices lifted oil-exposed currencies. However, money markets have not repriced Fed policy expectations, suggesting today’s decline in the dollar is relatively weak, as underlying fundamentals remain supportive. The sustained move above the 100 level since mid-June continues to reflect market expectations that the Fed will hike rates later in the year, leaving price direction vulnerable to the divergence in expectations between Fed and ECB rate expectations. The Fed’s meeting this week is not expected to bring any policy action, per money market odds. However, given Warsh’s preference for little-to-none forward guidance, the risk of an unexpected hawkish outcome should not be discounted.

Watch point: While markets are not expecting any change in policy from the Fed, a hawkish outcome should not be discounted. Meanwhile, underlying fundamentals remain supportive of the dollar.

EURO: The euro is 0.12% higher to $1.1383, gaining strength on the pause in US-Iran fighting. Bond yields across Europe have fallen in response to the pause in fighting as well, with the drop in oil easing some short-term inflation fears. Still, markets have not significantly repriced ECB policy expectations and given the broader risk backdrop, the inflation risk remains. The ECB considers the current inflation shock to be medium-sized, which requires some policy action but not aggressive moves. It expects price growth to return to 2% in the next year. Slovak Central Bank Chief Kazimir said a rate hike at the September meeting is likely needed. Money markets are pricing a near 70% chance of a hike in September and remain fully priced in for a move higher in October. ECB President Lagarde has also made clear that renewed energy shocks make the case for a September hike more likely. Lagarde warned that the “full effects of the energy shock have yet to play out” and that earlier hopes of a benign scenario were unlikely.

Watch point: With the pause in fighting supportive in the near-term, broader price direction will be subject to Fed-ECB policy expectations.

BRITISH POUND: Sterling is little changed at $1.3321. The pound remains caught between competing forces: rate hike expectations and questions surrounding the strength of the economy. While fiscal uncertainty has is still present for markets amid the new government, it has largely been priced in for some time and finance minister Healey has been a reassuring choice for gilt markets. Just like the ECB, the Bank of England is expected to keep rates on hold at its meeting this week. Still, traders remain fully priced for a hike come November. UK inflation data for June came in softer than expected, helped by a brief drop in fuel prices, though the result had largely been anticipated, so rate expectations were little changed.

JAPANESE YEN: The yen is 0.1% stronger at 163.71 yen per dollar. This week’s Bank of Japan meeting is likely to see no change in policy, leaving the focus on how strong or weak forward guidance from the bank is. Policymakers will likely stay ambiguous about further moves, though a lack of a commitment to raising rates is expected to leave a bearish pressure on the currency. The timing of the next move could be pushed forward to September or October if the BoJ raises the risk of an inflation overshoot. Verbal efforts to support the yen have had little effect on the currency, and official intervention is unlikely to offer a durable rebound unless the Bank of Japan commits to raising rates quickly. Therefore, BoJ rate hike expectations will continue to be the dominant driver in yen direction, outside of the geopolitical bid. With dollar/yen hovering in territory many view as too weak relative to fundamentals and JGB yields at multi‑decade highs, the consensus favors a gradual path toward a terminal rate near 1.5%, while the government’s recent reaffirmation of BOJ independence is intended to calm earlier jitters about political pressure to keep rates low. Still, Prime Minister Takaichi’s government has retained language in its economic blueprint urging the BoJ to align with government policy, fueling worries that Tokyo might pressure the bank to slow further hikes.

Watch point: With the yen sustaining a break above the 160 level, intervention from the government appears to be the greatest near-term risk against further depreciation.

AUSTRALIAN DOLLAR: The Aussie is 0.20% higher at $0.6994. Outside of US-Iran developments, quarterly inflation data on Wednesday will be in focus. The trimmed mean measure of core inflation is expected to rise 0.9% in Q2, lifting the annual rate to 3.7%. That would remain above the RBA’s 2%-3% target band, but below the central bank’s forecast of 3.8%. No significant upside surprise to core inflation should support market views that the RBA will keep rates on hold in August. Strong jobs data has added to expectations that the RBA will raise rates again before year-end, however. The Australian Bureau of Statistics showed net employment rose 76,300 in June from May, above forecasts of a 15,300 gain and moving the annual pace of job gains to 1.7% from 1%. The unemployment rate remained steady at 4.4%. Now, the RBA’s key concern is whether or not strong job gains turn into wage growth demands. Price pressure in the economy remain uncomfortably high, especially with crude up 26% this month. Traders are now fully priced for a rate hike by year-end.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to be in focus in upcoming data.

TREASURY FUTURES

Yields moved lower across the curve, the 10-year yield falling to 4.65%. While this week’s Fed meeting is not expected to bring any change in policy, the risk of a move higher in the Fed Funds rate or a hawkish vote should not be discounted. Ahead of the Fed meeting, oil prices will likely be in the driver seat regarding yield direction.  Still, the lack of certainty and flow of oil through the Strait continues to support upside risks in inflation and the higher-for-longer bond yields. Traders are now fully priced for a rate hike at the September meeting. A stable labor market has also supported the view that policymakers are expected to focus on taming inflation. A Reuters poll showed that economists are expecting the Fed to keep rates on hold for the remainder of the year, while a majority of those who answered a separate question about the chance of a rate hike this year now described the likelihood as “high”, a reversal from last month when most saw it as “low.”

Watch point: Mainly, the prospect that inflation will remain sticky reinforces a hawkish backdrop for the Fed over the medium-term.

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