Markets Calm Despite Ongoing Conflict

June 16, 2025

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The U.S. appears to be on the sidelines with regards to Iran and Israel; a sustained rise in oil prices will add to existing stagflation risks; the G7 summit got under way

Eurozone labor costs continue to ease; heightened uncertainty is keeping even the ECB hawks cautious

Two-day BOJ meeting began today; China reported mixed May real sector data

Markets have calmed despite ongoing hostilities between Israel and Iran. Oil prices are slightly lower on the day, with Brent currently near $74 after trading above $78 earlier today. Equity markets are higher, UST yields are higher, and gold is lower. The dollar is trading softer, with DXY back below 98 and on track to test last week’s low near 97.602. The euro is trading higher near $1.1580 while sterling is trading higher near $1.3585. Elsewhere, USD/JPY is trading flat near 144. With attacks still ongoing, it seems way too early to sound the “all clear” and yet risk assets are rising at the expense of the safe haven assets. We remain one headline away from another risk off episode. That said, we believe the fundamental dollar downtrend remains intact. With recent data coming in soft, we expect the Fed to deliver a dovish hold this week. Furthermore, we do not expect any significant trade deals to emerge from the G-7 summit and so tariff uncertainty should also continue to weigh on the greenback.

AMERICAS

The U.S. appears to be on the sidelines with regards to Iran and Israel. Yesterday, President Trump said “Sometimes they have to fight it out, but we’re going to see what happens.” This suggests that the US is unlikely to take an active role in brokering a peace deal. Trump has said similar things recently about the Ukraine-Russia conflict as it continues to rage. This means that upside risks to oil and inflation, downside risks to growth are building. This is obviously dollar-negative once we get past the “risk on, risk off” volatility.

A sustained rise in oil prices will add to existing stagflation risks. Despite today’s pullback, there is still scope for higher oil prices. Lower oil prices were a major reason for the lower inflation readings in H1, but it won’t take long for higher oil prices to start feeding into higher inflation readings in H2. Along with the likely hit to growth, the added stagflation risks (on top of the tariffs) will only complicate matters for the Fed. Even ECB hawks are sounding more cautious in light of the oil price spike (see below).

The G7 summit got under way. Trade discussions will be high on the agenda just weeks before the 90-day tariff pause ends on July 9. President Trump said he expects some trade deals to be made at the summit. While some minor deals or frameworks may be announced, we believe China, EU and Japan are far from striking any deal with the US. Furthermore, we expect Middle East tensions will take up much of the bandwidth at the summit, as well as the ongoing Ukraine-Russia conflict. Lastly, we do not expect anything specific about FX except the usual boilerplate language.

EUROPE/MIDDLE EAST/AFRICA

Eurozone labor costs continue to ease. Costs rose 3.4% y/y vs. 3.7% in Q4, which came in slightly above the ECB’s projection of 3.1% y/y in Q1. Last week’s ECB wage tracker points to subdued wage growth ahead. Indeed, the bank expects labor costs to drift down to its historical average of 2.0% by 2027. The swaps market implies just one 25 bp rate cut over the next 12 months that would see the policy rate bottom at 1.75%.

Heightened uncertainty is keeping even the ECB hawks cautious. Nagel said “Since crucial factors can change quickly in the current environment, we are well advised to remain flexible. This means that pre-determining the future - neither a further interest-rate cut nor a pause in monetary policy - is not sensible.” He added that “It is important to keep our eyes and ears open for risks to price stability. This is also true in light of current developments in the Middle East.” This is a sensible approach in light of the rising stagflation risks. That said, the market is pricing in one more 25 bp cut this year. Nagel speaks again later. Cipollone also speaks shortly.

ASIA

Two-day Bank of Japan meeting began today and ends tomorrow with an expected hold. The bank is widely expected to retain its commitment to raising rates if the outlook for economic activity and prices will be realized. There are no updated macro forecasts at this meeting, as the next BOJ Outlook Report is due at the next meeting July 30-31. The focus instead will be on the BOJ’s interim assessment of its JGB purchases tapering plan. The BOJ is currently trimming its JGB purchases by about JPY400 bln per quarter through March 2026. Given heightened volatility across all financial markets, we expect the bank to maintain the current pace of reduction in JGB purchases whilst reiterating that it stands ready to make one-off purchases as needed to smooth market functioning.

China reported mixed May real sector data. Retail sales came in at 6.4% y/y vs. 4.9% expected and 5.1% in April, while IP came in two ticks lower than expected at 5.8% y/y vs. 6.1% in April. Elsewhere, fixed asset investment came in at 3.7% YTD vs. 4.0% expected and actual in April, while property investment came in two ticks lower than expected at -10.7% YTD vs. -10.3% in April. The economy is holding up relatively well despite the trade war but deflation risks remain and so we look for more easing measures in the coming weeks.

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