Relief Rally Sweeps Markets

MACRO FRAME

Markets enjoy a relief rally on the Iran news, while inflation prints from Europe confirmed the conflict’s impact on energy prices. Meanwhile, March’s labor data supports the case for a Fed hold in the near-term.

STOCK INDEX FUTURES

US equity index futures are sharply higher following the announcement of a ceasefire between the US, Israel, and Iran. Contracts tracking the S&P 500 and the Dow gained nearly 3%, while those for the Nasdaq 100 jumped over 3.5%. The ceasefire was agreed for the next two weeks and reportedly included fees on tankers through the Strait of Hormuz. The developments triggered a plunge in oil and product prices, easing previous concerns of energy-driven inflation and supporting government bonds. The rekindle in risk sentiment supported speculative AI stocks, with Nvidia, Tesla, AMD, and Micron surging between 4% and 10% pre-market. Airlines also jumped on the improved outlook of jet fuel supply, and Delta soared 12% after posting earnings.

A stock market chart with a glowing green arrow climbing upwards and a red arrow descending, representing clear bullish and bearish trends.

Watch point: While the de-escalation supports equities, the conflict still presents real risks to future gains as US troops continue to move to the region.

CURRENCY FUTURES

US DOLLAR: The USD index is sharply lower as safe-haven demand and oil prices fall in response to the announcement of the ceasefire in the Middle East. The dollar index is at its lowest level in a month at 98.72. While the oil shock and safe-haven demand offered the dollar temporary support, underlying macroeconomic fundamentals make the case for a resumption of the dollar’s downward trend once hostilities in the Middle East are officially over. Despite rising inflationary pressures driven largely by energy prices, the dollar has lost its interest rate differential support it once drew from hawkish Fed expectations, support that has since been repriced away. With the labor market softening materially, the underlying case for a Fed rate cut later in the year remains intact, it is safe-haven flows, not monetary policy expectations, that are propping the dollar up at current levels.

Watch point: March’s NFP report and February’s JOLTS data confirms that a move up from the Fed is out of the picture and reinforced the narrative that the Fed is well positioned in its policy rate for the time being.

EURO: The euro is up 0.95% to $1.1705, a one-month high, as risk-on sentiment returns to markets following the ceasefire. The euro continues to find support from tighter monetary policy expectations, with markets pricing in two rate hikes from the European Central Bank this year, while the Fed stands poised to lower at some point. The ceasefire has dramatically shifted expectations for near-term tightening, with odds of an April hike priced at 33%, sharply below Tuesday’s 61% probability of a rate hike. Meanwhile, markets have priced out the possibility of a third hike by year-end, with 52 bps of total tightening expected vs. Tuesday’s 75 bps.

A sustained flow of oil through the Strait, paired with a drawdown in attacks on energy infrastructure support the view that the energy shock will be short-lived and ECB policy can stand in place. Recent data revealed core inflation in the eurozone fell to 2.3%, while a narrower measure that excludes food, energy, alcohol and tobacco held steady at 2.2%, unchanged from February. Services inflation, the stickiest and most policy-relevant component, actually eased to 3.2% from 3.4% in February. The critical risk factor is  the persistence of the energy shock.

Watch point: March’s inflation data confirmed that headline inflation was dragged higher by rising energy prices, while other components were reassuring to the broader inflationary picture. A rate hike at the ECB’s April meeting is unlikely, while the case for further tightening depends on the effectiveness of the ceasefire.

BRITISH POUND: Sterling is 1.35% higher to $1.3474, its biggest one-day gain in three weeks, as risk sentiment improved on the back of the ceasefire announcement. In response to the ceasefire announcement, traders have scaled back expectations on monetary policy from the Bank of England. Markets had previously been pricing in over 75 bps of tightening two weeks ago, and are now pricing just 30 bps of tightening by year-end. The sharp drawdown in tightening expectations is reflective of the weakness in the UK economy. Recent data has shown that economic growth remains stagnant, while business activity continues to grow at a slow pace. Additionally, slowing wage growth and a weak employment picture in the country remain favorable for policy easing by year-end rather than tightening. Before the outbreak of hostilities, markets were priced for a March rate cut given the falling inflation picture and material economic weakness. The case for policy easing out of the BoE remains subject to the effectiveness of the ceasefire and if oil prices can drop closer to pre-war levels. Given the uncertainties of the ceasefire and local elections in early May, the risk of further volatility remains. Keir Starmer’s governing Labour Party is trailing the populist Reform UK and the left-wing Green Party.

Watch point: The de-escalation between the US and Iran provides short-term support to GBP, but pre-war macroeconomic factors present a hurdle for BoE policy tightening.

JAPANESE YEN: The yen rose 1% against the dollar to 158.03 yen per dollar as investor sentiment brightened following the developments in Iran. Overnight data from Japan supported the narrative of broadening, persistent wage growth that reinforces the BoJ’s tightening path. Average cash earnings in Japan rose 3.3% YoY, above forecasts for a rise of 2.7%. The data comes as Japan’s labor federation secured a 5.26% average wage hike for the third consecutive year in spring negotiations. February’s cash earnings represent realized growth flowing through to worker paychecks. Money markets are pricing a 53% chance of a hike from the Bank of Japan at its April meeting and are fully priced for a hike come July.

Watch point: An April rate hike could pull USD/JPY closer to 155, though the odds of such happening appear unlikely at the time being.

AUSTRALIAN DOLLAR: The Aussie is up 1.4% $0.7074 as the risk-linked currency was supported by the positive developments in the Middle East. It is a thin week on the economic calendar, lending attention to developments in Iran. Markets imply a 55% chance of another quarter-point rise in May, though that was down from near 70% last week, and see rates at 4.61% by year-end. Analysts at HSBC now expect Australia’s economy to contract in the second quarter after two rate hikes this year, and higher fuel prices to weaken consumer spending.

TREASURY FUTURES

Yields are sharply lower across the curve, with the 10-year yield down 10 bps to 4.24% as global bonds rallied on the ceasefire news. Foreign central banks have significantly reduced their holdings of US Treasuries at the NY Fed to the lowest level since 2012, as countries sell US bonds to support their currencies and fund expenditures. Gulf states, who traditionally benefit from higher oil prices, have been forced to curtail oil production in response to the closure of the Strait of Hormuz and subsequent attacks on energy infrastructure. The lack of a revenue driver for the Gulf states has lead the countries to sell US Treasuries in order to generate funds.

Friday’s payrolls report did little to move Fed policy expectations, with markets pricing in no change to the Fed Feds rate by year-end. However, we look for the Fed to lower rates once by year-end, with a reduction most likely in September. One-year inflation have fallen in response to the ceasefire, currently priced below 3%  ahead of March’s inflation data, which is likely to show a sharp, energy-induced spike in prices. Treasury’s are likely to continue to trade off  energy prices and further Iran-related developments ahead of March’s inflation data.

Watch point: Following March’s labor data, an immediate case for a change in Fed policy remains unlikely. March’s CPI data is expected to show a rise in prices, though evidence of sustained inflation will be closely monitored for impacts on policy expectations.

The spread between the two- and 10-year yields is 50.80 bps, while the two-year yield, which reflects short-term interest rate expectations, is 3.73%.

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