Still No Peace Deal

MACRO FRAME

Global bond yields remain elevated as markets eye the await the outcome of President Trump’s “pause” on attacks. While tech/AI leadership may continue to provide a floor, the combination of firmer energy-driven inflation, heightened Fed tightening expectations, and rising geopolitical risks leaves overall sentiment fragile ahead of the weekend.

STOCK INDEX FUTURES

Equity index futures moved lower overnight as oil prices rose. Markets continue to await news over some form of deal or peace resolution between the US and Iran, sentiment which has been preventing further losses in the equities. However, with the weekend approaching and President Trump suggesting attacks could resume soon, further downside risk remains. Markets have also shrugged off yesterday’s hawkish FOMC minutes, while AI and tech related optimism continue to provide strong tailwinds and underpin broader risk sentiment. Strong earnings revisions, supported in part by ongoing AI-related capital expenditures, have helped offset macro headwinds. However, valuation signals are becoming more stretched: the 10-year Treasury yield now exceeds the S&P 500 earnings yield by the widest margin since the early 2000s, historically a cautionary signal for equities. For now, equities continue to outperform bonds, but the growing disconnect between rates and risk assets warrants closer attention.

Watch point: While the bond sell-off has yet to meaningfully impact equities, higher yields could temp a rotation away from risk assets and into rates as markets await the outcome of President Trump’s pause on strikes.

CURRENCY FUTURES

US DOLLAR: The USD index is 0.27% higher at 99.35, finding strength from the upward move in oil prices and hawkish tone in yesterday’s FOMC minutes. Overall, the bias for the dollar remains higher given current conditions, though a peace deal or framework as an outcome of President Trump’s announcement of a ceasefire extension could unwind flight-to-quality longs and see the dollar drop substantially. Still, underlying fundamentals remain solidly bullish for the dollar: the US interest rate differential continues to expand as a Fed rate hike becomes increasingly expected by markets in later months. Odds of a December rate hike are 57%. 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 expected a move upwards.

Watch point: Stalled optimism around a US–Iran resolution will continue to offer safe-haven support for the dollar. Fed policy expectations are likely to reinforce near-term dollar strength, though a peace deal could unwind recent strength.

EURO: The euro fell 0.30% to $1.1593. PMI readings out of the eurozone largely came in below expectations; France’s PMI data showed the economy contracting at the fastest pace in five years. Eurozone Composite PMI came in at 47.5, down sharply from 48.8 in April, a 31-month low, marking the second consecutive month of contraction and the sharpest pace of decline since October 2023. S&P Global Chief Business Economist Chris Williamson noted that the survey data now point to the euro area economy contracting by approximately 0.2% in Q2, driven by a deepening cost-of-living squeeze tied to the war in the Middle East. The PMI data highlights major stagflation risks for the eurozone economy, with inflation gauges hinting that eurozone CPI could be running close to 4%, deepening the dilemma for the European Central Bank: cutting rates risks stoking inflation further, while holding or hiking would worsen a rapidly softening growth backdrop.

Dollar strength remains the prevailing theme in currency markets with oil prices higher and jitters over geopolitics. For the euro, the prospect of slower economic growth and higher interest rates as a result of the US-Iran conflict reinforce downward pressure on the currency as the eurozone remains particularly vulnerable to the energy crisis. Markets are currently pricing a 87% chance of a hike at the June meeting and are nearly priced for two additional rate hikes by year-end.

Watch point: While a June rate hike remains the favorable move from the ECB, a well-positioned policy stance could lead to a hold. However, recent inflation data out of the US likely underscores that policy will move moving upwards in the near-future.

BRITISH POUND: Sterling is little changed at $1.3422. UK Composite PMI collapsed to 48.5 in May from 52.6 in April to mark a 13-month low and the first sub-50 reading since April 2025. The services sector, the engine of the UK economy, drove the entire deterioration, with its PMI crashing to 47.9, the lowest reading since January 2021. Firms reported a sharp drop in new business as consumer-facing industries bore the brunt of Middle East war-related uncertainty and persistently high energy costs. Meanwhile, input cost inflation stayed highly elevated despite a slight moderation from April’s record monthly surge. Today’s data puts the Bank of England in a deeply uncomfortable spot, mirroring the ECB’s stagflationary bind.

UK inflation came in below consensus in April; headline CPI came in softer than expected (2.8% vs. 3.0% consensus), driven by the energy price cap reset, a one-time government policy effect that will base-effect out in coming months. The BoE’s April letter to the Chancellor had flagged that services inflation was expected to fall from 4.5% to around 3.8% by September; the April print of 3.2% came in well ahead of that trajectory, which might give the BoE more room to maneuver on rate cuts. However, the crude oil input cost surge (+75.4% YoY) is a significant concern for pass-through back into CPI over the next 2–3 quarters. Meanwhile, data from Tuesday that showed businesses in the UK slowed hiring and posted fewer job vacancies, while the unemployment rate ticked up to 5% for the first quarter, from 4.9% in Q1.

JAPANESE YEN: The yen held slipped 0.13% against the dollar to 159.13 yen per dollar. Japan’s Flash Composite PMI fell to 51.1 in May from 52.2 in April, the softest reading in five months and the weakest growth recorded in 2026 so far. Meanwhile, input cost inflation climbed at the fastest rate since late 2022, driven by supply disruptions, higher energy prices, and elevated raw material costs tied to the Middle East conflict. Selling prices also rose at their fastest pace in 19 years of survey data to mark a record high.

Bank of Japan policy board member Junko Koeda offered hawkish comments overnight, saying that the central bank needs to continue to raise rates with underlying inflation already around a 2% target. Apart from dollar strength and the geopolitical premium, anticipation of details surrounding the government’s additional budget plan, which markets fear will strain public borrowing, is keeping the yen on the backfoot. Meanwhile, intervention risk remains front of mind for traders as the yen has fallen closer to the 160 level. Markets are pricing a 76% chance of a hike from the Bank of Japan come June. Recent wholesale inflation data has bolstered the case for the BoJ to tighten policy. For the yen, intervention alone is likely not going to be sufficient enough to strengthen the currency given Japan’s vulnerabilities to higher energy prices.

AUSTRALIAN DOLLAR: The Aussie fell 0.34% to $0.7126 following a surprisingly soft set of job data overnight, which has tempered some expectations on near-term rate hikes from the Reserve Bank of Australia. Australia reported a drop of 18,600 in employment for April, missing market forecasts of a 15,000 gain. The unemployment rate rose to 4.5%, above forecast of 4.3%, to mark the highest level since 2021.

The Aussie has been subject to rapid changes in sentiment in recent trading sessions, often trading the mood regarding developments out of the gulf. Interest rate differential support for the Aussie is also waning a the spread between Australian 10-year and US 10-year has fallen to its weakest level this year. The RBA is still expected to raise rates one more time this year, though against the backdrop of a hike in Fed policy, interest rate differential support is not as strong as a factor. Markets imply around a 12% chance of a June hike to the 4.35% cash rate, while the probability of an August hike to 4.60% fell to 46% from 60%.

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 moved higher across the curve as energy prices rose overnight. Yesterday’s FOMC meeting minutes were the key macro event, and they confirmed that “many” voting Fed members are now moving toward raising rates as inflation remains above the 2% target. In Fed language, “many” falls just short of a “majority” and suggests that the three Fed presidents who dissented on the decision to leave the statement unchanged had support from some other non-voters. For the Fed, it would appear that they are not leading the bond market, but following it.

For bonds, the risk of even higher yields remains heading into the weekend with seemingly no additional progress made between US-Iran negotiations. While a rotation away from equities and into bonds amid higher rates could trigger a relief rally, underlying inflation fundamentals are structurally bearish for bonds, especially as expectations of a hike in policy from the Fed grow, absent any developments in the Gulf. The two-year yield rests well above the upper-bound of the Fed Funds rate, alongside surging inflation for both consumers and producers, reinforcing the narrative that rates will remain higher for longer. In macro context, the median and trimmed mean inflation components have ticked above 3%, while the Fed’s supercore (services inflation minus shelter) also rose above 3% indicating there is more to inflation than the first-order effects from the oil shock. Bond yields have risen in such a way that suggests the Fed is behind the inflation curve, presenting Warsh with a potential bond market revolt if he presses for lower rates.

Watch point: The path to loosening has faded materially 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 next month would open the door for a path to easing.

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