Key Takeaways
- A tentative ceasefire between Iran and Israel has triggered a relief rally in financial markets. The oil price has eased by some margin and US equities ended last week at record highs.
- With Middle East tensions easing, attention will likely shift to US tariffs and President Trump’s ‘Big Beautiful Bill’ which Congress is looking to pass by the 4th July.
- The deadline for tariff negotiations is looming and consensus suggests many will settle around the 10% baseline mark.
- It is too early to draw conclusions on the impact of tariffs on inflation but there is a building view that the impact will be limited.
- The Federal Reserve remains in ‘wait and see’ mode but markets continue to price in two 25 basis point cuts before the end of the year.
It has been another extraordinary week of geopolitical developments with the backdrop considerably more benign than a week ago thanks to a tentative ceasefire between Israel and Iran. There has been a relief rally in financial markets – most visibly through a substantial drop in the oil price and US equities ending the week at record highs.
The week began with the potential for the US to be drawn into a major conflict following its attack on Iranian nuclear facilities but the response from Iran was more symbolic and designed for a domestic audience rather than a further provocation to the US.
As a result of the limited response by Iran, the US, Israel and Iran have taken the ‘off ramp’ to a ceasefire rather than pursuing an ongoing conflict. President Trump declared the ‘12-day war’ as over after Israel and Iran agreed to a US-brokered ceasefire, heralding a possible end to almost two weeks of conflict between the regional rivals.
There is a significant difference between a ceasefire, a peace settlement and a military defeat and from a geopolitical point of view the Middle East remains a highly unstable region. Israel and Iran are sworn enemies, and Israel will continue to act to ensure Iran cannot build nuclear weapons, which means that any signs of Iran progressing in this respect could result in the return of hostilities.
But for financial markets, we can move on and concerns over spikes in oil resulting from the closure of the Strait of Hormuz or attacks on the US can be put to rest for now. Hence the slump in the price of oil over the course of recent days, to levels last seen before Israel attacked Iran earlier this month. Before the recent escalation, the oil price was expected to be around $60 by year end, thanks to abundant supply and soft demand. This morning Brent Crude trades at $67 per barrel, still reflecting some risk premium from geopolitical risk but a long way from trading above $81 per barrel as we saw briefly last Monday, and a very long way from levels above $100 per barrel that would really weigh on risk appetite.
With the Middle East tensions potentially falling down the headlines, the focus may shift back to two other themes that have dominated financial markets this year – the trade war and the US budget. President Trump continues to pressure Congress to pass the ‘Big Beautiful Bill’ by the 4th of July so the next 48 hours or so will be pivotal in meeting this deadline, and to allow markets to digest what does or does make it into the final version, and by how much it will increase the US deficit over the next decade.
Meanwhile the 9 July deadline for trade ‘deals’ to avoid reciprocal tariffs is now moving into view. We are a very long way from the 90 deals in 90 days that President Trump promised, but the consensus view appears to be that the US will not go much beyond the 10% baseline tariff, though that may not be the case for all the US’s trading partners. It also seems likely that countries making progress in talks for deals may well be given some more time beyond the 9 July – others may not be so fortunate.
There is also a building view that the tariffs will not have a significant impact on inflation, but arguably it is too early to draw conclusions with tariffs only having been in place for a few months, and at varying levels. History shows that there tends to be a lag of at least three months before tariff hikes are passed on so it is too soon to draw conclusions. The 20% tariff on washing machines in 2018 took around three-four months to impact pricing. In the May inflation data, there were signs of inflation in some areas such as car parts, but given the spike in inventories ahead of tariffs, many goods on sale during May, when CPI was ‘soft’, would have been imported before tariffs kicked in, and it would appear some firms are reluctant to pass price rises on until they have more visibility on where tariffs will settle in the longer term.
Markets are pricing two 25 basis point rate cuts in the US before the end of the year, with cuts in September and December. For now, there is no reason for the Federal Reserve (Fed) to change policy – neither inflation or unemployment are indicating a need for immediate action and with plenty of uncertainty ahead, it makes sense for the Fed to ‘wait and see’ over the summer and hope for a little more clarity by September. But a few ‘softer’ CPI prints in the US will see the clamour for rate cuts getting much louder, not least from the White House.
