Oil Lower Supportive of Equities

MACRO FRAME

Global markets are focused on US-Iran talks to reopen the Strait of Hormuz. The renewed negotiations between the two countries offers markets a test to distinguish between positive negotiations, or a durable de-escalation. Whether tankers can begin to move freely will be the penultimate factor in restoring optimism.

STOCK INDEX FUTURES

Equity index futures are higher overnight, largely thanks to the AI-trade, which has powered the Nasdaq and S&P to record highs as investors have been piling into chip stocks. Oil prices fell further, with crude falling under $95 a barrel. While still elevated, the market has taken the prices in stride in expectation that the inflationary effect will be transitory. Tomorrow’s PCE data will offer a fresh momentum test for markets, especially with the details surrounding US-Iran talks remaining cloudy. PCE inflation is expected to come in at 3.8% YoY, with the core measurement up 3.3% YoY, while headline spending will be driven higher by gasoline prices. Tomorrow’s data is likely to offer little reprieve to broader inflation concerns, leaving further focus to US-Iran talks for guidance on market direction. Lower oil prices should also ease market expectations over Fed policy tightening, as a restoration of oil flow should deter the central bank from raising rates.

Watch point: Details regarding tanker traffic through the Strait will be a catalyst for global markets and may significantly reprice expectations over Fed policy.

CURRENCY FUTURES

US DOLLAR: The USD index is 0.20% lower at 98.97 as peace-deal optimism and lower oil prices weigh on the dollar, though there has not yet been a major unwinding of flight-to-quality longs. Currencies of countries more exposed to oil flows have rallied on lower oil prices and the pickup in risk sentiment. A detailed announcement of a peace deal and restoration of oil flows through the Strait could seriously unwind flight-to-quality longs and see the dollar drop substantially. Still, underlying fundamentals remain mildly supportive of the dollar given the inflationary backdrop and the fact that there is still no deal between the US and Iran, though that is a fluid development. Odds of a December rate hike have fallen to 44% from 51% on Tuesday as expectations of a reopening of the Strait have eased some inflationary concerns among market participants. While recent labor data did reveal some notable spots of weakness, the overall market narrative is that the Fed will keep a hold on rates while a growing chorus of participants are beginning to expect a move upwards in the absence of oil flows through the gulf.

Watch point: Optimism over a formal US-Iran deal will unwind flight-to-quality longs, and reduce tightening expectations, ultimately weighing on the dollar.

EURO: The euro is 0.19% higher at $1.1653 as optimism over a potential US-Iran deal lifts the currency. Given Europe’s energy reliance on oil imports, any positive news regarding the US-Iran conflict is likely to lift the currency. However, that would consequently reduce expectations of policy-tightening from the European Central Bank, which could curb the upside, though relief from lower prices is likely to be a stronger factor. Still, if a deal were to materialize quickly, supply chains will take time to normalize, which is likely to keep inflation and interest rate concerns in place. Recent eurozone PMI data from last week highlighted major stagflation risks for the eurozone economy, as private sector activity fell sharply with the survey data pointing to a 0.2% contraction in Q2 GDP, while inflation gauges suggested eurozone CPI could be running close to 4%, deepening the dilemma for the ECB. Money markets are placing an 93% chance of a hike at the June meeting and see 57 bps of tightening by year-end, down from expectations of nearly 75 bps two weeks ago. For the euro, broader risk sentiment will continue to determine price direction, while the interest rate differential against the dollar remains unfavorable.

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

BRITISH POUND: Sterling is little changed at $1.3449 as traders remained cautious in the currency across the channel. UK gilt yields, which have risen more than any G10 nation since the start of the war, were down 5 bps on the day at 4.826%. Prospects of a durable peace agreement between the two countries is likely to offer the pound with temporary support, though pre-war macroeconomic factors are likely to continue to weigh on the currency. The negative impacts on business activity and lackluster hiring alongside slowing wage growth reinforce our view that the BoE has limited scope to tighten policy and that money markets are overestimating the bank’s ability to raise rates. Money markets are pricing a 11% chance of a hike at its June meeting and see 36 bps of tightening by year-end, which is substantially lower than market-pricing two weeks ago, but still rests above our base case.

Watch point: We expect macro factors to pressure the pound following a formal cease in hostilities between the US and Iran. We look for GBP/USD to weaken over 2H 2026, though the pound is likely to find near-term support from positive developments out of the Middle East.

JAPANESE YEN: The yen is little changed against the dollar at 159.40 yen per dollar as the currency nears levels which previously saw intervention from government authorities in the currency market. Bank of Japan Governor  Ueda struck a hawkish tone on Wednesday, saying the war-driven oil shock could become persistent in an environment of high inflation expectations and rising wages. Given that the market is leaning optimistically toward a deal, and if that scenario were to play out, the yen would appear to be undervalued against the dollar. Money markets continue to favor a rate hike at the bank’s June meeting, with odds priced at 69%, while the market sees a total of 41 bps of tightening by year-end. Intervention risk is likely to provide the currency support at the 160 level.

Watch point: Given the current status quo, the yen is likely to consolidate in the 157-159 range, unless policy support from the BoJ firms.

AUSTRALIAN DOLLAR: The Aussie fell 0.45% to $0.7137 as CPI data missed expectations, with prices in April rising 0.4% MoM, below forecasts for 0.6%. Annual  inflation slowed to 4.2% from 4.6%, though that was in part because of government tax break on petrol. However, the key trimmed mean measure of core inflation rose 0.3% as expected, taking the annual pace up to 3.4%, which is likely to keep the Reserve Bank of Australia on its tightening bias. Markets have slashed tightening expectations, implying a 6% chance of a June hike to the 4.35% cash rate, while a December hike has fallen from being fully priced in just a 63% chance. Labor data last week revealed a surprise 18,600 drop in employment for April, missing market forecasts of a 15,000 gain. The soft data initially tempered market expectations of RBA policy tightening. Still, elevated inflation pressures, which were present before the outbreak of conflict in Iran will force the RBA to maintain its tightening bias.

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 keep the RBA on a tightening path.

TREASURY FUTURES

Yields are modestly lower across the curve, with Treasury holding a tight range ahead of tomorrow’s PCE data and as markets await further details of US-Iran talks. For bonds, little has changed in terms of price response to geopolitical developments. Downside risk remains Iranian opposition to peace talks and a continuation of stalled traffic in the Hormuz, while inflation fundamentals remain unfavorable ahead of Thursday’s PCE data, which is likely to offer little hope of easing price pressures. Freight costs continue to rise in response to higher energy costs, underscoring a backdrop of building inflationary pressures across the board. Market pricing reflects this dynamic with two-year yields holding well above the upper bound of the Fed Funds rate. Additionally, Fed Governor Waller said it is “crazy” to talk about rate cuts given current inflation, and explicitly stated he “can no longer rule out rate hikes further down the road if inflation does not abate soon.” Given that the median and trimmed mean inflation readings both sit above 3%, while the Fed’s supercore measure also sits over 3%, it is unlikely that the Fed will move on policy in 2026.

Against this backdrop, yields appear to be adjusting as if the Fed is behind the curve, ultimately supporting a view that bonds are likely to remain under moderate pressure and consolidate rather than sustain a durable rally. The upside for bonds remains tied to developments between the US and Iran, mainly the resumption of energy and other commodity flows through the Strait, though pass-through effects are likely to remain present for several quarters even a swift resumption of flows occurs.

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. However, a swift reopening of the Strait in the coming weeks would open the door for a path to easing.

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