Red Sea Threats

MACRO FRAME

The military exchanges between the US and Iran re-inflate the geopolitical risk premium in energy and add a hawkish skew to the macro backdrop.

STOCK INDEX FUTURES

Equity index futures are mixed with the Nasdaq and S&P falling lower on tech/chip weakness while Healthcare kept the Dow flat ahead of the bell. The setup for today appears to signal a rotation rather than a broad risk-off move with defensives and select earnings winners offsetting pressure in the semis. Retail sales for June largely matched expectations, while May’s figures were revised higher. Chip stocks are extending declines from the previous session, while investors favor big bank names after strong bank earnings. TSMC is down in pre‑market trading even after reporting a 77% jump in Q2 profit and announced an extra $100bn of US investment, highlighting positioning risk in AI‑beneficiary names amid even-higher capex announcements. TSMC said capex over the next three years will be “even more significantly higher” than in the past three, signaling high conviction in a multi‑year AI megatrend. Memory names are among the biggest decliners, underscoring that semis, which led much of this year’s rally on AI optimism, are now a source of near-term drag for the Nasdaq.

Geopolitical headwinds are also giving investors reason for caution today: Tehran has asked Yemen’s Houthi movement to stand ready to close the Red Sea oil route if the US attacks Iranian power infrastructure, according to multiple regional and Iranian sources. With Iran’s closure of the Strait of Hormuz, a substantial amount of Gulf oil has been rerouted to the Red Sea via Saudi pipelines; the Red Sea now carries around 7% of global energy supplies, and is the main alternative route for regional exports.

CURRENCIES

US DOLLAR: The USD index is 0.10% higher at 100.59, picking up some strength after June’s retail sales data, though the release was rather benign in terms of its inflationary print. The dollar was near a one-month low (100.3 level) level with recent weakness attributable to the inflation prints this week, which have reduced odds of near-term tightening expectations from the Fed. Chances for a Fed hike in July were cut to 11%, versus a 45% implied probability at the start of the week. Markets are still priced for a rate hike by December. Still, the bias for the dollar remains higher as treasury yields remain elevated with the two-year yield currently trading near 4.17%, while the geopolitical backdrop also points to elevated safe haven demand amid the current uncertainty in the Gulf and Red Sea. For the dollar, unlike earlier phases of the conflict, the dollar is starting from a stronger base and with expectations of Fed tightening already priced in, so the scope for an additional war-driven surge is limited.

Watch point: June’s inflation data is bearish for the dollar, though the report’s impact may be partially overshadowed by the current geopolitical backdrop and the rise in oil prices.

EURO: The euro is little changed at $1.1455. European gas futures have risen to their highest levels since March, furthering upside risks to inflation in the eurozone and raising risks that higher energy costs would weigh on the economy and euro. After this week’s US inflation data, the ECB is now seen as more hawkish than the Fed, with markets nearly priced for two additional rate hikes by the end of the year, seeing 44 bps of total tightening.  Final CPI figures for the eurozone tomorrow will be closely watched for rate-hike timing expectations out of the European Central Bank, though against the current geopolitical backdrop and rise in energy prices traders and policymakers could discount the most recent inflation data if energy prices continue to rise.

Watch point: With the MOU seemingly done with, policy expectations are biased upwards though performance of EUR remains dependent on US inflation data and domestic growth factors.

BRITISH POUND: Sterling is 0.28% weaker at $1.3505 after data overnight showed GDP rose 0.1% in May, exactly in line with forecasts, reversing April’s 0.1% decline and signaling only minimal MoM growth. Over the three months to May, output grew a robust 0.7%, and an upward revision to 0.8% for the three months to April means the economy has been expanding at close to its fastest pace in roughly two years. On a YoY basis, May GDP was 1.3% higher, the strongest annual increase in about 10 months. May’s growth was entirely driven by services but industry and construction still contracting, underscoring an economy that is growing but remains fragile beneath the surface. Largely, the prospects of UK economic growth remain uncertain, as Burnham’s policies present an unknown. Still, markets are less worried about the fiscal landscape as Andy Burnham is expected to appoint Shabana Mahmood (currently interior minister) as finance minister rather than the more left‑leaning Ed Miliband, which is seen as modestly supportive for fiscal discipline.

JAPANESE YEN: The yen is little changed at 162.28 yen per dollar. Recent headlines on potential moves by Japan’s Government Pension Investment Fund (GPIF) after Finance Minister Katsunobu Kato said last week the government wants a “substantial” increase in domestic asset investment have been the mainstay in recent direction for the yen. The announcement is also seen as a way for the government to reduce depreciation in the yen using official-sector capital allocation. Still, this process would be the start of a multi-year restructuring rather than an immediate shift into yen. For now, the announcement remains modestly positive, while existing dynamics continue to pressure the yen. No new data overnight lends focus to developments in the Gulf and potential intervention from the government. For the yen, bearish pressure in expected to continue in the near-term. Investors are awaiting official intervention data later this month to determine whether the government was behind the yen’s sharp but short-lived rally on July 2. The market little changed regarding Bank of Japan policy expectations, pricing about 22 bps of tightening by year-end, with a move expected to come in January of 2027.

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 0.13% weaker at $0.6999. Australian bond yields have eased slightly as traders remain pessimistic over prospects of any tightening from the Reserve Bank of Australia. Markets are pricing a 53% chance of a hike before year-end and are flirting with the idea of rate cuts in late 2027. A survey of businesses out on Tuesday showed conditions remained soft in June, before the renewed fighting in the Gulf, while cost pressures eased modestly. Meanwhile, a separate survey showed the mood among consumers improved a little in July, but again that will be challenged by rising fuel prices. Renewed fighting in the Gulf presents a bearish risk for the Aussie. US-Iran developments will be closely watched in another thin week of economic data in Australia. With markets awaiting further data on the economy, the Aussie is likely to remain subject to geopolitical developments, mainly regarding moves in oil.

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 higher across overnight, June’s retail sales data modestly pressured bond prices as the reading is solid enough to keep pressure on inflation. Meanwhile, weekly jobless claims continued to support the narrative of a stable labor market. The two-year yield at 4.17% is the greatest indicator that Fed policy could move higher later in the year despite a pullback in near-term tightening expectations. Money markets are priced for a hike in December but have pulled back on bets of near-term tightening after this week’s inflation data. While PPI and CPI prints for June came in weaker-than-expected, the data still supports a hawkish bias from the Fed. Largely, the reaction from markets was that the data was not as bad as it could have been. The Fed will probably need to see further benign inflation readings before ruling out a rate hike later this year.

Watch point: Mainly, the renewed fighting and prospect that some inflation remain sticky reinforce a hawkish backdrop for the Fed despite a drop in the headline reading.

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