Markets Bounce on US-Iran News

MACRO FRAME

The US and Iran have agreed to a framework deal to end their conflict, reopen the Strait of Hormuz, and move toward broader negotiations—though major issues (Lebanon conflict, nuclear program) are not fully resolved yet.

STOCK INDEX FUTURES

Equity index futures are sharply higher to start the week, aided by the news that the US and Iran have reached a memorandum of understanding to end the war and reopen the Strait. The agreement is set to be signed Friday. Oil prices fell 5% lower overnight, with WTI trading at $80bbl. The largest downside risk for the agreement would appear to be the hostilities in Lebanon;  if Israel–Hezbollah fighting continues or escalates, it could derail the ceasefire framework, reintroduce geopolitical risk premiums, and trigger a renewed spike in oil prices that pressures global equities. The drop in oil prices has eased bets of near-term rates hikes from the Fed, supportive of the equities, though last week’s data is likely to keep the central bank on hold for the remainder of the year. Largely, traders are still favoring a move upwards, though expectations of a hike in the next twelve months is likely to fade. Equities remain broadly supported by earnings upgrades, particularly in semiconductors where AI‑driven demand has pushed profit expectations sharply higher. Recent weakness has highlighted how narrowly the rally is concentrated in just a handful of crowded AI and tech names. At the same time, index gains rest increasingly on optimistic earnings assumptions, one‑off mega‑cap gains, and policy‑related tax tailwinds, leaving markets historically expensive on long‑term metrics and vulnerable if growth, cash‑flow conversion, or tech capex discipline disappoint, especially with performance dispersion near COVID‑era and dot‑com extremes and the S&P 500’s advance since late February almost entirely driven by AI stocks.

Watch point: While May’s softer core CPI print reduces the urgency for additional Fed tightening and should be welcomed by equities, core inflation remains above target, suggesting policy will stay restrictive and reinforcing the case for selectively adding some defensive positioning alongside exposure to the ongoing tech‑led momentum.

CURRENCIES

US DOLLAR: The USD index fell 0.2% to 99.55, alongside the drop in oil prices as a broad risk-on rally takes place in the markets. The dollar is likely to lose support from an unwinding of Fed rate hike expectations. Current pricing has pushed back expectations of a hike to March 2027 from December on Friday, a dynamic that is likely to continue as long as oil prices continue to drop. The geopolitical bid remains the dominant factor in price direction for the dollar. Further details of the peace deal and reopening of the Strait are likely to continue to direct flows away from the dollar and ease hawkish policy expectations from the Fed; signs of a breakdown in negotiations and a resumption of fighting will further safe have demand for dollar liquidity. Last week’s inflation data is likely to keep policymakers at the Fed from moving on rates for the remainder of the year.

Watch point: A durable peace agreement and drop in oil prices is likely to unwind expectations of Fed policy tightening, which could erase support for the dollar and see it fall closer to the 99 level in the near-term.

EURO: The euro is 0.37% higher at $1.1612, lifted by the drop in oil prices and rise in risk sentiment following the US-Iran news. European Central Bank President Lagarde welcomed the news but warned of emerging second-round effects from the conflict. ECB’s Nagel added that oil supply recovery would take months, delaying any inflation relief for some time. The ECB revised its inflation forecasts higher and its growth projections lower yesterday after it raised rates by 25 bps to 2.25% last week. Money markets continue to expect one more rate hike from the ECB this year, though a fully priced hike has been pushed out to December from earlier pricing of September. For the ECB, policy is likely to remain biased upwards, though a continued easing in services inflation could dull some expectations of a move upwards. 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 peace deal and restoration of oil flows through the Strait is likely to push back tightening expectations, the ECB remains biased upwards in its policy trajectory and traders should be watchful of another rate hike in the next two quarters.

BRITISH POUND: Sterling is 0.12% higher to $1.3422. FX markets will see a slate of UK data this week, with inflation figures, labor market data and retail sales all due. Meanwhile, the Bank of England will meet on Thursday and is expected to leave rates on hold. Money markets have pared back expectations of policy tightening this year, and recent GDP data showed the economy contracted 0.1% in April. We continue to expect no upwards policy action from the central bank. Politics will come back into the focus in a local election that could result in contention of Prime Minister Starmer’s position.

JAPANESE YEN: The yen is little changed at 160.13 yen per dollar. Attention this week will focus on Bank of Japan Deputy Governor Shinichi Uchida, will brief the media on behalf of Governor Kazuo Ueda, over the outlook for the BoJ’s rate-hike path. Traders are expecting the bank to hike rates, though the yen is lacking support from further expectations of policy tightening from the BoJ. Cautious commentary could favor the yen bears, though intervention risk remains front of mind for traders as the currency remains above the 160 level. With policy rates still deeply negative in real terms, incremental moves are unlikely to deliver a durable yen rebound or materially change Japan’s still-fragile exit from deflation. Instead, markets are increasingly focused on the broader policy mix: rising long yields alongside a weak currency highlight concerns over Japan’s heavy debt load, while political support for a weaker yen, equity benefits from FX depreciation, and reluctance to tackle the debt overhang suggest any sustained yen strength will require more than rate hikes alone. The market sees a total of 44 bps of tightening by year-end. Intervention risk continues to offer the currency support around the 160 level.

AUSTRALIAN DOLLAR: The Aussie is sharply higher at $0.7071, as the recent news between the US and Iran lifted risk-sentiment. The Reserve Bank of Australia is likely to hold on rates Tuesday. Focus will center around whether or not a reopening of the Strait is enough to soothe inflation fears at the RBA and whether or not underlying inflationary pressures still present upside risks. Bonds in Australia have priced out any expectation of a near-term hike. The NAB recently called off their expectation of another rate hike from the RBA, saying they expect a slowdown in the economy to limit price growth. Meanwhile, a mix of softer economic data has led markets to pare back expectations of another rise in the RBA’s policy rate. Still, demand is largely outpacing supply, labor conditions remain tight, leaving the inflation bias pointed upwards. The RBA has broadly signaled that it is in a wait-and-see mode following three rate hikes earlier this year and as a result markets are no longer any hikes by the end of the year. However, the trimmed mean measure of inflation sits at an annual pace of 3.4%, which is likely to reinforce a tightening bias from the RBA.

TREASURY FUTURES

Yields are lower across the curve in response to the US-Iran news ahead of the Fed’s first Warsh-led meeting this week. Negotiations on aspects of the deal are ongoing, but no doubt policymakers will be relieved that the upside risks to inflation appear to be receding. The two-year remains above 4%, a key signal that the bond market is not totally relieved from the recent news. Recent inflation data has reinforced a hawkish-leaning hold, but removed any immediate urgency to move rates higher. Markets are expecting a hold this week, but expectations of a hike later in the year have been priced out, with markets now pricing a hike for March of 2027. The bond market will continue to look toward oil prices for cues on the direction of yields. Oil will likely need to drop closer to $65bbl for rate-hike expectations to null significantly. For now, price pressures have proven relatively transitory without presenting a durable second-round impulse. If core CPI prints above 3.0% annualized in coming readings, that argument becomes hard to sustain.

Watch point: The Warsh-led Fed is likely to hold on rates for the remainder of the year, though second-round inflation effects present moderate upside risks to inflation in upcoming data.

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