Markets Re-Focus On Fundamentals As Peak Geopolitical Risk Passes

WHERE WE STAND – Participants have now decisively drawn a line under geopolitical tensions, with peak risk clearly in the rear view mirror, allowing folk to re-focus on the fundamental backdrop.

That, clearly, remains a bullish one when it comes to risk appetite, with incoming economic data continuing to hold up well, earnings growth solid, and trade rhetoric continues to cool. Unsurprisingly, equities charged higher once more yesterday, with spoos now within touching distance of a fresh record high, and that milestone likely to be achieved in relatively short order.

Of course, that is not to say that there are no risks whatsoever. The most notable, though, at least in terms of scheduled events, are still a week or so away – namely, the June jobs report on 3^rd July, and the expiry of the ‘Liberation Day’ tariff pause on 9^th July. While I fully expect the can to be kicked on that latter front, and the pause extended, it would be nice to get confirmation of that sooner rather than later, as this void of information could prove more of a headwind the closer that we get to the deadline.

Amid all of that, the Fed doesn’t really feature in the calculus right now, as the FOMC remain firmly in ‘wait and see’ mode, barring fairly obvious politically-motivated dovish overtures from Governors Bowman and Waller. Chair Powell was on Capitol Hill yesterday, though his remarks brought nothing by way of surprise.

J-Pow very much stuck to the script outlined at last Wednesday’s press conference, noting that policy is ‘well-positioned’, allowing the Fed to wait before considering any further rate cuts, while also reiterating that both the economy and the labour market remain ‘solid’, and that the effects of tariffs, and other fiscal policy changes, on risks to the dual mandate ‘remain uncertain’.

I think we can say with quite some certainty that a July cut won’t be happening, given Powell’s remarks, but we are now dealing with the very real possibility of a bitterly divided Fed Board at the next meeting. Not a particularly great look, nor is it especially good for monetary policy transmission, which will likely be weakened considerably as a result.

That does beg the question of when the next cut may come, or at least what will feed into the FOMC’s thinking around that timing. I’d argue that policymakers will want not only to be confident that the impact of any tariff-induced inflation is temporary, but also to have a forecast for near-term disinflation in the SEP. While there’s a chance that Powell could use Jackson Hole to make a dovish pivot ahead of a potential September cut, I still view it as much more likely that the FOMC instead hold off until December before a further rate reduction, delivering just one 25bp cut this year.

Still, that neutral FOMC stance doesn’t seem to be bothering participants in the FX market particularly much. In fact, the overall degree of policy divergence is relatively slim, with the ECB on hold now unless an external factor forces their hand, the BoE sticking resolutely with their ‘gradual and careful’ approach, and most other G10 central banks – besides the RBA, and Norges Bank – already at, or very close to, the end of their cycles.

At large, the overall driver of the FX complex, at least in DM, continues to be a slow but steady grind lower in the dollar, as outflows appear to gather pace. Of course, President Trump having once again turned his ire towards the FOMC, and resumed ranting about the need for rate cuts, won’t be helping here, as reserve allocators continue to diversify their holdings. The EUR, which reclaimed 1.16 yesterday, is the obvious candidate to benefit the most here, though gold is also likely to attract considerable inflows amid this continued diversification, even if the yellow metal did come under some selling pressure yesterday.

Outside of the FX complex, yesterday, the fallout from the marked de-escalation in Middle East geopolitical tensions continued. Crude benchmarks fell another 6% or so, practically erasing all of the risk premium that had been priced, though in a vastly over-supplied market I’d not be betting against further declines. This move, in turn, allowed Treasuries to gain across the curve, as inflation expectations repriced lower, with benchmark yields falling about 5bp from 2-30y, helped along by a well-received 2-year sale.

LOOK AHEAD – It’s not exactly the most exhilarating docket which lies ahead today.

On the data front, things are very light indeed, with only the latest US new home sales figures due; personally, I can’t remember the last time that they moved markets more than a tick in either direction.

Elsewhere, Fed Chair Powell is once again on Capitol Hill, for day two of the semi-annual Humphrey-Hawkins testimony, though comments should by and large be a reiteration of those made yesterday. US supply is also due, with a 5-year sale later, which should be taken down well, while notable earnings today come from the likes of Micron and Jefferies.