Risk Sentiment Holds Ahead of the Weekend

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 sentiment in the hands of the geopolitical bid.

STOCK INDEX FUTURES

Equity index futures moved modestly higher overnight as lingering optimism over a US-Iran deal, strong PMI data from the US, and spillover from yesterday’s blue-chip rally supported sentiment. The Trump administration is reportedly set to invest $2 billion into various quantum computing companies, with IBM being a main beneficiary and receiving $1b. The news helped push the Dow to close at an all-time high. However, broader risk sentiment hangs on uncertain geopolitical footing. There are conflicting reports that the Iranian supreme leader has drawn a hard line, insisting enriched uranium must stay in Iran, which is a non-starter for the US. With US attack deadlines spanning today through early next week, the weekend is presents a massive gap risk at Monday’s open. AI and tech related optimism continue to provide 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: Strong earnings have provided a catalyst for bulls in the equities, while AI and tech related optimism also support sentiment. However, this weekend presents real risk stemming from US-Iran nuclear negotiations.

CURRENCY FUTURES

US DOLLAR: The USD index is 0.11% higher at 99.36, largely staying rangebound as it is caught between two opposing forces: peace-deal optimism and the looming US attack deadline. After building strength off war premium this month, markets appear hesitant to extend bids until the Iran deadlines pass or attacks materialize. 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 0.15% to $1.1600. Germany’s IFO business climate data overnight posted a clean sweep of positive readings, and Q1 German GDP came in better-than-expected at +0.4%, yet the euro still struggled to rally, underscoring the dollar’s structural edge. Eurozone PMI data from Thursday highlighted major stagflation risks for the eurozone economy, private sector activity falling 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.

Cutting rates risks stoking inflation further, while holding or hiking could worsen a rapidly softening growth backdrop. This dynamic could limit the amount of policy tightening from the central bank, though the ECB is remains better-suited to endure higher rates, unlike its peer across the channel, given its stronger economic position before the war. Money markets are placing an 85% chance of a hike at the June meeting and see 61 bps of tightening by year-end, down from expectations of nearly 75 bps last week. For the euro, broader risk sentiment will continue to determine price direction, while the interest rate differential against the dollar remains unfavorable.

BRITISH POUND: Sterling is little changed at $1.3425. UK data showed April retail sales fell 1.3% MoM, more than double the consensus forecast of -0.6% and the largest monthly decline since May 2025. On an annual basis, sales were flat (0.0% YoY), a notable drop from March’s +1.4% YoY print. Core (ex-fuel) retail volumes fell a more modest -0.4% MoM, highlighting that fuel was the single biggest distortion in the headline. Fuel volumes collapsed -10.2% MoM, the sharpest single-month fuel decline since November 2020. This data fits the stagflationary narrative built in Thursday’s UK PMI data, reinforcing that consumers are under real stress as energy costs and price sensitivity are suppressing spending.

UK Composite PMI showed private sector activity falling to a 13-month low as input and output cost inflation remained elevated. Firms noted they were passing cost increases onto customers. Firms also reported a sharp drop in new business as consumer-facing industries bore the brunt of US-Iran war-related effects. However, April’s CPI data earlier in the week has offered some reassurance that inflation pressures are not entirely out of control; headline CPI came in softer than expected at 2.8% (3.0% consensus), though that was driven by the energy price cap reset, a one-time government policy effect that will base-effect out in coming months. However, services inflation at 3.2% came in well below the Bank of England’s expectations, which expected services inflation to fall to 3.8% by September. The reprieve in services inflation offers the BoE more room to maneuver on policy given that the crude oil input cost surge (+75.4% YoY) presents real risks for pass-through into CPI over the next 2–3 quarters. On the labor front, Tuesday’s data showed businesses in the UK slowed hiring and posted fewer job vacancies alongside a rise in the unemployment rate.

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 16% chance of a hike at its June meeting, a sharp drop from Monday’s pricing of nearly 40% and see 50 bps of tightening by year-end.

JAPANESE YEN: The yen held slipped 0.13% against the dollar to 159.12 yen per dollar. Core inflation in Japan slowed to a four-year low, per new data overnight. Core CPI, rose 1.4% YoY in April, slower than March’s 1.8% rise and below the median market forecast of 1.7%. A drop in education fees weighing on service-sector inflation and offset increases in other items. Still, markets are generally expecting inflation, including core, to pick up in the coming months.

Japan’s Flash Composite PMI reflected the softest reading in five months as input costs rose at their fastest rate since late 2022. Output prices also rose at their fastest pace in the 19 years of survey data. Still, the composite reading (51.1) remained above contractionary territory suggesting that overall private sector activity continued to grow. For the Bank of Japan, the rise in inflationary pressures does provide it with an easier path to raise rates, though the bank will remain cautious of the slowdown in the services sector, a key driver of economic activity and employment for the country. If a sustained slowdown in services activity realizes, the BoJ will have to reduce tightening ambitions in favor of supporting economy growth, though this scenario rests on the assumption that US-Iran related shocks are not temporary. Money markets continue to favor a rate hike at the bank’s June meeting, with odds priced at 73%, while the market sees a total of 46 bps of tightening by year-end. 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 provides the currency support at the 160 level.

AUSTRALIAN DOLLAR: The Aussie fell 0.25% to $0.7129 as investors digest conflicting signals over peace prospects in the Gulf.  Labor data on Thursday revealed a surprise 18,600 drop in employment for April, missing market forecasts of a 15,000 gain. The soft data has tempered market expectations of Reserve Bank of Australia policy tightening, with markets pushing back a fully priced rate hike to December. Still, elevated inflation pressures, which were present before the outbreak of conflict in Iran will force the RBA to maintain its tightening bias. 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 has slowly waned with the spread between Australian 10-year and US 10-year has fallen to its weakest level this year at 38 bps, a sharp drawdown from 83 bps back in early March. Against the backdrop of hawkish Fed policy expectations, interest rate differential support is not as strong as a factor for the Aussie. 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 are modestly lower across the curve as the relief rally in the bonds continues. Stochastics are rising from oversold levels, though the moves seem familiar to a bounce in a bear market. The oil market remains the main driver in price direction, with moves lower in oil friendly to gains and vice versa. For bonds, downside risk remains tied to a lack of progress in peace talks heading into the weekend, and while a rotation out of equities and into bonds amid higher rates could spark a near-term relief rally, the broader macro backdrop continues to argue for consolidation with a bearish tilt. Inflation fundamentals remain structurally unfavorable, with two-year yields holding well above the upper bound of the Fed Funds rate alongside firm consumer and producer price pressures, reinforcing the higher-for-longer narrative. In macro context, median and trimmed mean inflation have both moved above 3%, while the Fed’s supercore measure has also re-accelerated past 3%, underscoring that inflation persistence extends beyond first-order oil effects. At the same time, April FOMC minutes confirmed that “many” policymakers are now leaning toward further tightening—a signal just shy of a majority that still points to growing internal support for hikes and diminishing odds of a near-term easing pivot under Warsh. Against this backdrop, yields appear to be adjusting as if the Fed is behind the curve, raising the risk of bond market pushback if policy turns prematurely accommodative, and ultimately supporting a view that bonds are likely to remain under moderate pressure and consolidate rather than sustain a durable rally.

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 next month would open the door for a path to easing.

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