Measures of market stress are moderating ahead of a week crammed with a combustible array of potential volatility catalysts including an escalation in Middle East hostilities, three major central bank meetings and a raft of first-tier economic data. Treasury yields are ticking higher, equity futures are pointing to a recovery from Friday’s losses, and the dollar’s gains are fading in the face of renewed advances from the euro, Canadian dollar, Mexican peso, and Australian dollar.
An easing in geopolitical uncertainty is putting safe-haven currencies under pressure and oil prices are retreating after Israel and Iran avoided targeting critical energy infrastructure in a series of airstrikes over the weekend. Israel struck two gas processing plants near the Persian Gulf along with a fuel depot and refinery in Tehran on Saturday, and an Iranian missile damaged a refinery in Haifa, but both sides stopped short of hitting production and export facilities critical to global supply chains.
Both of the major global crude benchmarks jumped on Friday as traders braced for a potential disruption to shipping through the Strait of Hormuz, given that it remains a critical chokepoint for global energy shipments. Most analysts believe that Tehran’s reliance on export revenues and desire to avoid bringing the United States into the conflict will prevent any attempt to shut Middle Eastern trade routes — and oil markets are still very well-supplied — but the risk premium built into futures prices has risen relative to the levels that prevailed ahead of the latest round of attacks.
Somewhat unusually, investors are keeping a close eye on headlines emanating from the Group of Seven meetings in Kananaskis. The gathering, which typically culminates in an anodyne and (frankly speaking) economically-meaningless joint communiqué, will instead feature smaller chair-level statements and a series of one-on-one conversations between Donald Trump and aggrieved US trading partners, set against a backdrop in which the Israel-Iran conflict exposes underlying geopolitical fractures. Markets could see some upside — in the event that the US falls in line with European proposals for a lowering of the Russian oil price cap or strikes trade “deals” with key allies — but are also vulnerable to downside if a repeat of the fractious 2018 summit plays out, tariff increases are put back on the agenda, or Trump rebukes Ukrainian President Volodymyr Zelenskyy in public once again.
A rate adjustment at tomorrow’s Bank of Japan meeting appears unlikely. While inflation remains resilient — and may yet accelerate, given that Japan relies on imports from the Middle East to meet roughly 35 percent of its energy needs — domestic growth has disappointed and rising tariff risks are casting a shadow over the economic outlook. Caution is warranted. However, officials may opt to moderate the pace of quantitative tightening in an effort to restore stability in long-term government bond markets. After expanding its share of government bond issuance to levels far exceeding those of other advanced economies, the Bank began tapering its purchases by 400 billion yen per quarter last August. This has contributed to deteriorating market liquidity and allowed 30-year yields to breach the 3.2 percent mark in late May. A slower pace of tapering — perhaps to 200 billion yen — now looks possible, potentially easing upward pressure on long-term rates, and reducing stress in other fixed-income markets around the world.
Tomorrow could bring evidence of a retrenchment in American consumer demand. After a spectacular post-pandemic rebound and a surge in tariff front-running earlier in the year, economists think headline retail sales likely fell -0.1 percent in May as households slowed auto purchases, while so-called “control group” sales continued their decline for a second month.
But the Federal Reserve could sound relatively hawkish on Wednesday. In a series of recent appearances and speeches, a number of officials have pointed to still-solid activity data, continued strength in labour markets, and tariff-led inflation risks in justifying a longer waiting period before resuming rate cuts. Updated forecasts in the Statement of Economic projections — colloquially known as the ‘dot plot’ — could illustrate a more stagflationary outlook, with year-end inflation and unemployment expectations pushing higher, even as the median participant moves toward expecting just a single rate cut this year, and a more gradual easing trajectory in 2026. Depending on positioning going in, this “high-for-longer” message could keep Treasury yields elevated and the dollar supported, although we’re mindful of thinner liquidity in the run-up to the Juneteenth market holiday on Thursday.
