Anthony Willis
Senior Economist, Multi-Asset Solutions team
Top stories
- The US and Iran spent the week exchanging missile and drone strikes but at a level that indicates that both countries are not yet willing to breach the threshold that would bring an end to the two-month ceasefire. The week is ending on a more optimistic note as President Trump yesterday cancelled further strikes on Iran, saying that a deal was imminent, and could be signed as soon as this weekend.
- The European Central Bank raised interest rates by 25 basis points, to 2.25%, as expected, stating that the war in the Middle East is “generating inflation pressures”. The bank raised its 2026 inflation forecast to 3.00% and expects inflation to remain beyond target in 2027, at 2.3%. The ECB revised down their expectations for economic growth, with 0.8% expected for 2026 and 1.2% in 2027. This appeared to be an ‘insurance’ hike, raising policy now to not fall too far behind the inflation wave, but Christine Lagarde said this was not the case and was a “pretty obvious step” and a “good decision…we do have inflation that is too high for our citizens, that is too high for the purpose of price stability”. Lagarde said that eurozone growth was not “under significant threat” and highlighted “we are not seeing, yet, second rounds effects” of inflation”.
- President Trump said he was not looking to renew the comprehensive trade deal struck with Mexico and Canada during his first term in office. The three countries had a deadline of 1 July to extend the USMCA trade deal or face rolling annual reviews over the next decade. Trump claimed the US “does not need anything” produced by Mexico and Canada. The US imported $534 billion of goods from Mexico and $383 billion of goods from Canada last year; combined this represents 28% of all US imports.
By the numbers
- 4.2% – the year-on-year increase in US inflation in May. The figure was in line with expectations, as energy prices increase price pressures. The Bureau for Labor Statistics reported fuel prices continued to underpin inflation with the cost of petrol up by about 50% since the Iran war began in February. Core CPI (which excludes food and fuel costs) provided more reassurance that wider price pressures remained limited. Core CPI increased to 2.9% year on year from 2.8% previously.
- 172,000 – the increase in US non-farm payrolls of expectations. The update boosted expectations that the Federal Reserve will raise interest rates this year. The consensus figure for May was 85,000. Historic data for March and April was revised higher by a combined 93,000. Markets are now pricing 25 basis points of Fed tightening this year, with a rate hike in December.
Market movers
- We appear to be in a more volatile period in equity markets, after a strong run over several weeks took many indices to what appeared to overbought levels. Such phases of consolidation are to be expected, but while shifts in the US-Iran situation continue to move markets, sentiment is shifting somewhat on the outlook for interest rates, particularly in the US, where markets are now expecting a hike this year. This is a big contrast to six months ago when two or three rate cuts were anticipated in 2026. Elsewhere, rate hikes are already expected. The uptick in US inflation comes as no surprise given the energy price shock, but the latest employment data combined with positive historic revisions paints a healthier picture of the US labour market, and with the Fed’s dual mandate covering employment and inflation, the employment side of the equation is in decent health while inflation is well above target. We should note, however, that the inflation outlook can still shift considerably; core inflation remains contained, and any resolution in the Middle East would remove price pressures. Equally, survey data still points to a softening in the labour market, which is not yet showing in the official data. For now, the Fed can ‘wait and see’, so new Chair Kevin Warsh is unlikely to oversee a policy move when he Chairs his first rate setting meeting next week. President Trump commented that raising interest rates “would be the wrong thing to do” and has previously called for the Fed’s benchmark rate, currently 3.5-3.75% to be cut to 1% or lower”.
The investment lens
- Concerns over escalation in the Middle East this week has not been reflected in the oil price, which has remained below $100/barrel and has now dipped sub $90 on the positive headlines yesterday. This is a long way from the $60 average level predicted for 2026, but well off the conflict highs of $126/barrel. But you will likely recall predictions of $150+/barrel if the Strait of Hormuz was closed for an extended period; i.e. more than three months. So, what is keeping a lid on oil prices? Firstly, there is still a belief, despite the constant threats to the ceasefire over the past fortnight, that some sort of peace deal will be reached. Despite more hawkish language in the past few days, President Trump has again suggested a deal is imminent. For markets, the challenge has been deciphering whether Trump’s comments reflect genuine diplomatic progress or simply another iteration of his negotiating style. Optimistic talk of imminent peace has repeatedly been followed by renewed threats, deadlines and warnings. Secondly, the Strait of Hormuz has not been as ‘closed’ as would first appear, with some ships making ‘dark’ transits of the Strait, switching off their GPS locators, and travelling at night close to the coast of Oman, under US air supervision. Other vessels have been transiting close to the Iranian coast, under Iranian supervision now that the mechanism for a toll payment is established under the Persian Gulf State Authority. While the numbers are considerably lower than pre-war levels, it is helping at the margin. Thirdly, inventory drawdowns have helped offset supplies stuck in the Gulf. Inventory levels should last several more months before they reach ‘critical’ levels, but this would suggest that as the autumn approaches, there are upside risks to the oil price, which may increase the pressure on the US to finalise a peace deal, or some sort of compromise that will lead to a resumption of shipping before oil supplies become scarce.
