PCE Supports Fed Hold

MACRO FRAME

Global markets are focused on US-Iran talks to reopen the Strait of Hormuz. The renewed negotiations between the two countries offers markets a test to distinguish between positive negotiations, or a durable de-escalation. Whether tankers can begin to move freely will be the penultimate factor in restoring optimism.

STOCK INDEX FUTURES

Equity index futures are lower overnight after the US and Iran exchanged strikes overnight, though the indexes have recovered from session lows following this morning’s PCE data, which came in better than expected at a 0.4% MoM headline gain vs. expectations of 0.5%. Consequently, following the latest out of the Middle East, oil prices have rebounded and weighed on sentiment as it appears unlikely that a swift resolution is around the corner, reinforcing inflation concerns which have been responsible for market weakness in recent weeks. Still, the strikes are limited in nature and it appears that both sides are still at the negotiating table, though peace prospects appear weaker than they were to start the week. The market does appear confident that both sides will agree to a peace deal, but the overnight strikes do offer some investors an opportunity to take in profits following the strong tech-fueled rally.

Watch point: Details regarding tanker traffic through the Strait will be a catalyst for global markets and may significantly reprice expectations over Fed policy.

CURRENCY FUTURES

US DOLLAR: The USD index is little changed at 99.16 as peace-deal optimism fades following overnight strikes and as oil prices moved higher. The dollar is dealing with two opposing forces this morning: softer-than-expected PCE data and investor flight to safety in the dollar. Despite April’s PCE data coming in below expectations, the reading is still sat at nearly 4% YoY, too high for the Fed to begin thinking about cutting rates, which should the dollar some support. A detailed announcement of a peace deal and restoration of oil flows through the Strait could seriously unwind flight-to-quality longs and see the dollar drop substantially. Still, underlying fundamentals remain mildly supportive of the dollar given the inflationary backdrop and given recent statements from FOMC members, which have become increasingly hawkish in recent days and weeks, which is also a reason for the shift in market expectations towards interest rate hikes

Odds of a December rate hike are at 44%. Expectations of a reopening of the Strait have eased some inflationary concerns among market participants in recent days despite the flareups.

Watch point: Optimism over a formal US-Iran deal will unwind flight-to-quality longs, and reduce tightening expectations, ultimately weighing on the dollar.

EURO: The euro is 0.14% higher at $1.1643, bouncing from an overnight low of $1.1586. Expectations of policy-tightening from the European Central Bank have offered some support to the euro against recent dollar strength as investors increasingly expect a hike at the June meeting. Money markets are placing an 93% chance of a hike at the June meeting and see 57 bps of tightening by year-end, largely unchanged over the past week, though down from expectations of nearly 75 bps two weeks ago. 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 June rate hike remains the favorable move from the ECB, a peace deal and restoration of oil flows through the strait is likely to reduce  tightening expectations.

BRITISH POUND: Sterling is 0.10% lower to $1.3415, coming off overnight lows as traders remained cautious amid the flare up in tensions overnight. While the UK remains under the cloud of uncertainty related to political leadership, statements from PM front-runner Andy Burnham that he would stick to the UK’s fiscal rules, have calmed currency markets and relieved pressure the Sterling. However, recent weak economic data has tempered interest rate hike expectations and reinforced 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 11% chance of a hike at its June meeting and see 37 bps of tightening by year-end, which is substantially lower than market-pricing two weeks ago, but still rests above our base case.

Watch point: We expect macro factors to pressure the pound following a formal cease in hostilities between the US and Iran. We look for GBP/USD to weaken over 2H 2026, though the pound is likely to find near-term support from positive developments out of the Middle East.

JAPANESE YEN: The yen is little changed against the dollar at 159.40 yen per dollar. Intervention risk continues to offer the currency support near the 160 level, which has previously seen intervention from government authorities in the currency market. While a sharp rebound in the yen appears unlikely at the time being, the yen appears to be slightly undervalued given the Bank of Japan’s bias toward hiking rates and government intervention support. Money markets continue to favor a rate hike at the bank’s June meeting, with odds priced at 71%, while the market sees a total of 40 bps of tightening by year-end. Bank of Japan Governor  Ueda struck a hawkish tone on Wednesday, saying the war-driven oil shock could become persistent in an environment of high inflation expectations and rising wages.

Watch point: Given the current status quo, the yen is likely to consolidate in the 157-159 range, unless policy support from the BoJ firms.

AUSTRALIAN DOLLAR: The Aussie fell 0.13% to $0.7130 as risk sentiment waned overnight and as data showed consumer spending surprising fell. Household spending slid a 1.1% in April as consumers cut back on travel, clothing, and food amid the conflict in the Middle East. However, business investment grew 6.5% in Q1. Still, for the Reserve Bank of Australia, the fall in spending suggests that higher interest rates are helping to curb demand and reducing inflationary pressures, though given the conflict, it remains yet to be seen whether or not this is confidence driven or as a result of monetary policy. CPI data on Wednesday missed expectations, with prices in April rising 0.4% MoM, below forecasts for 0.6%. Annual  inflation slowed to 4.2% from 4.6%, though that was in part because of government tax break on petrol. However, the key trimmed mean measure of core inflation rose 0.3% as expected, taking the annual pace up to 3.4%, which is likely to keep the Reserve Bank of Australia on its tightening bias. Markets have slashed tightening expectations, implying a 9% chance of a June hike to the 4.35% cash rate, while a December hike has fallen from being fully priced in just a 62% chance.

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 little changed across the curve in reaction to this morning’s PCE data. April’s headline PCE came in slightly below the FactSet consensus of +0.5% MoM and +3.9% YoY, while core landed in-line at +0.2% MoM and +3.3% YoY. The deceleration in the monthly headline print (+0.4% vs. March’s +0.7%) reflects some moderation in energy price gains, though prices for gasoline and energy goods remain significantly elevated relative to year-ago levels given the ongoing Middle East conflict. Core PCE at 3.3% YoY, up from 3.2% in March, is particularly notable from a Fed policy standpoint. The monthly core print of +0.2% is the softest reading in recent months (versus a run of +0.3%/+0.4% prints through Q1 2026), though it is premature to read this as a definitive cooling. On an annualized basis, the 0.2% monthly core print is still well above the Fed’s 2% objective and should keep rate cuts out of the picture for the Fed.

Downside risk for bonds remains Iranian opposition to peace talks and a continuation of stalled traffic in the Hormuz. Two-year yields continue to hold well above the upper bound of the Fed Funds rate, reinforcing market expectations of a Fed that has shifted to the hawkish side. Fed Governor Waller said it is “crazy” to talk about rate cuts given current inflation, and explicitly stated he “can no longer rule out rate hikes further down the road if inflation does not abate soon.” Given that the median and trimmed mean inflation readings both sit above 3%, while the Fed’s supercore measure also sits over 3%, it is unlikely that the Fed will move on policy in 2026. Yields appear to be adjusting as if the Fed is behind the curve, 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.

Interested in more futures markets?  Explore our Market Dashboards here.