AWARDS
Yesterday, while US and UK markets were closed, news of a peace agreement fueled considerable optimism. Crude oil prices plunged more than 7% and the US dollar weakened, with the Swedish krona and Australian dollar among the best-performing G10 currencies, thanks to improving global growth prospects. However, US strikes in the region overnight undermined this optimism and created greater uncertainty. The retracement of yesterday's optimism-fueled moves has not been fully completed today, with US officials continuing to indicate that negotiations for a deal are ongoing. With only a moderate rebound so far, the decline in crude oil is significant: since the beginning of last week, Brent crude oil is now down nearly 15%, underscoring the level of optimism now priced in that a deal is being reached.
Marco Rubio downplayed the US strikes, saying that talks would take "a few days," while President Trump wrote that negotiations were "progressing well." US Central Command described the strikes as defensive and said they targeted launch sites and vessels attempting to plant mines. Negotiations also appeared to be stalled over certain issues, such as Iran's ability to control traffic through the Strait of Hormuz and how to manage Iran's stockpiles of enriched uranium. These are issues that have long been a source of disagreement, and therefore there is reason to be skeptical about the imminence of an agreement. While President Trump was quick to emphasize progress and the imminent agreement, Iran actively denied reports of a deal. An Iranian spokesperson acknowledged the progress but dismissed the idea of an imminent agreement.
This would suggest, especially after the US strikes, that there is a risk of a further retracement from yesterday's market movements. Yesterday's currency movements were more muted than those of crude oil or interest rates: the 2-year German Bund yield fell 10 basis points, but the EUR/USD fluctuated only 30 pips, perhaps due to the closure of the UK and US markets. The most significant moves were in the Swedish krona (SEK) and the Australian dollar (AUD), and there is certainly room for a larger retracement in these pairs if a deal is not announced soon. The EUR/USD could underperform due to expectations of a significant escalation in the conflict between Russia and Ukraine, following reports that Russia has asked the United States to evacuate its diplomats from Kiev ahead of an expected escalation in attacks. The euro lagged the G10, placing it at the bottom of last Friday's performance chart.
US yields look set to continue supporting the dollar, with Fed officials increasingly focused on inflation risks. Fed Governor Waller's speech last week underscored this shift, signaling a potential rate hike if "inflation doesn't subside soon." We don't believe there will be a rate hike this year, and indeed, if a credible peace agreement is reached, a rate cut by the end of the year remains feasible. However, until both sides formally announce a deal, investors are likely to tread carefully, given rising inflationary pressures.
