By Michael Brown, Senior Research Strategist at Pepperstone
DIGEST – The first signs of potential de-escalation in the ongoing Middle East conflict brought a distinctly positive, risk-on vibe to trade on Monday, with crude rolling over, and stocks charging higher. Geopolitics, plus PMIs, are in focus today.
WHERE WE STAND – The rollercoaster ride continues. Headline whiplash has seldom been greater. The noise/signal ratio remains off the charts.
Yesterday, we had another example of President Trump’s ‘escalate to de-escalate’ negotiating strategy, or perhaps a ‘TACO’ moment if one is so inclined. Via Truth Social, of course, Trump noted that ‘very good and productive’ conversations had taken place with Iran, on the subject of a ‘complete and total’ resolution of Middle East hostilities. Said conversations as such led to the announcement of a five day postponement of US strikes against Iranian energy infrastructure.
Now, there was some uncertainty as whether those talks had actually taken place. Iranian state media denied it, while other outlets reported that various back-channel discussions had in fact occurred in recent days. Frankly, I don’t think this whole ‘Schrodinger’s talks’ thing really matters, and whether or not talks have taken place is somewhat immaterial.
The signal here is clear, and is as follows – Trump has pulled back on the ultimatum issued over the weekend, is seemingly seeking de-escalation for the first time since conflict begun, and looks to be trying to find an off-ramp to allow that to happen. To me, this is by far the most important part of all this.
That said, time for some caveats. While a positive development, Trump has only mentioned power plants, meaning the potential for kinetic action elsewhere is still present. Plus, the 5-day pause hinges on progress being made in talks, which is clearly not guaranteed. lastly, at risk of stating the obvious, the Strait of Hormuz is still essentially impassable, and commodity supply continues to tighten as a result.
Despite those caveats, participants – rightly, in my view – focused on the positives yesterday, and signs that we might finally be seeing a faint chink of light at the end of the tunnel when it comes to the ongoing Middle East conflict.
That positivity saw stocks gain ground on both sides of the pond, albeit with some profits being taken as the day wore on, though the S&P still notched its best day since the Middle East conflict began, and just the fourth daily gain of over 1% seen this year. Elsewhere, crude benchmarks plunged, with Brent and WTI settling around 10% lower apiece; Govvies rallied across DM, with STIRs joining in too, amid falling inflation expectations; gold, and silver, recovered all the losses seen early on in the day amid capitulation during the APAC session; and, finally, the greenback lost ground against most major peers amid diminished haven demand.
With all that in mind, the obvious question now is where markets go from here?
Unsurprisingly, it remains the case that incoming headlines will continue to dictate sentiment for the most part. Further signs of progress being made on a ‘deal’ between the US and Iran would clearly be cheered by risk assets, as would any indication that the aforementioned pause in strikes was being either extended, or broadened to a wider range of potential targets being ‘off-limits’. Naturally, indications contrary to this, or renewed escalation, would be elicit the opposite market reaction.
The biggest ‘prize’, though, remains re-opening the Strait of Hormuz. It is this pinch point that is the nub of the issue, given it triggering the surge in energy prices that we’ve seen in recent weeks, and with that in turn having sparked fears of higher inflation, slower growth, and potentially a tighter monetary policy stance. Restoring a more normal level of energy flow, or at least taking a concrete step towards doing so, is a prerequisite to reversing all of those factors.
Still, while there’s clearly a long way to go until some sort of ceasefire is agreed, and peace restored, we do at least seem to have taken the first step towards those ends. It is, clearly, too early to signal the ‘all clear’ just yet, though yesterday’s events do once again evidence that Trump remains responsive to pressure from financial markets.
Given that hopes for a swifter de-escalation have been rekindled, further signs of positivity are likely to embolden equity dip buyers for the time being. In any case, we seem to have found Trump’s pain thresholds – 6,500 in spoos, and more pertinently 5.00% in the benchmark 30-year yield.
One other thing that yesterday reinforced was the idea that participants don’t want to be ‘caught short’, with the long-awaited ‘TACO moment’ seemingly now starting to take place, nobody wants to be the last bear to change their mind, when all of those bears are rushing for the exit at the same time.
LOOK AHEAD – ‘Flash’ PMIs are today’s main calendar highlight, though of course focus will also fall heavily on geopolitical developments, given Trump’s 5-day pause on strikes targeting energy infrastructure as outlined above.
Still, those PMIs will be of particular interest, as they are the first ‘proper’ read that participants will get on the initial impact not only of elevated geopolitical uncertainty, but also the surge seen in commodity prices. I’d wager that risks tilt to the downside in terms of consensus expectations, not least considering that the PMIs do tend to over-state the magnitude of major ‘out of the blue’ economic events.
Besides the PMIs, we have manufacturing data from the Richmond Fed, as well as a 2-year Treasury auction, which should be taken down relatively well. There’s also a busy calendar of central bank speakers, including Fed Governor Barr and BoE Chief Economist Pill.
