Amid geopolitical conflict, central banks prepare for rate announcements

In focus this week

Fighting between Israel and Iran enters its fourth day with continuous air assaults from both sides. Over the weekend, the conflict continued to escalate. Israel expanded its bombardment to target Iranian energy facilities while continuing to attack nuclear sites and residential areas. Iran's retaliation similarly targeted Israel's military and energy infrastructure. Both sides have suffered civilian casualties. The expansion of the warfare to include critical energy infrastructure heightens the risks for global energy markets even if the attacks thus far have not affected global supply.

Multiple central bank rate announcements are set for release, including decisions from the Bank of Japan on Tuesday, the Fed and Riksbank on Wednesday and Norges Bank, Bank of England and the Swiss National Bank (SNB) on Thursday. We expect all but the SNB to stay on hold and expect the SNB to cut the rate 25bp to 0%.

Economic and market news

What happened overnight

China released the big monthly data batch. Retail sales rose much stronger than expected from 5.1% y/y to 6.4% y/y (cons: 4.9% y/y), likely due to a trade-in program. To get a sustained lift in consumption, a housing recovery is somewhat necessary. Home sales stayed at a weak level in May and the data now looks more like stabilisation at a low level than the moderate recovery that seemed to be materialising in Q1. Home prices also dropped at a faster rate in May with new home prices down -0.22% m/m from -0.12% m/m in April. Industrial production was close to expectations at 6.3% y/y (cons: 6.4% y/y, pre: 6.4% y/y). We look for a continued muddling through with 4.7% GDP growth this year as stimulus compensates for trade war headwinds. However, a self-sustained recovery is still at least 1-2 years away.

What happened over the weekend

In the Middle East, geopolitical tensions are once again reigniting following Israel's strike on Iran early Friday morning. The fighting is expected to drag on as Israel has hinted that the operation is likely to last for weeks, not days. Iran, in turn, has communicated that it would be willing to stop the attacks if Israel did the same. The nuclear talks between the US and Iran are cancelled until further notice. Key triggers for escalation from the markets perspective include: 1) Israeli attacks disrupting Iranian oil production, 2) Iran or its proxies targeting Gulf oil production sites, 3) Iran targeting US bases, 4) Iran disrupting traffic via the Strait of Hormuz as a last resort. Regarding triggers 2-4, the US would find it hard not to intervene.

In the US, the University of Michigan's June flash survey signaled further improvement in sentiment and lower inflation expectations. Sentiment improved to 60.5 from 52.2 in May, significantly overshooting consensus expectations of 53.5. Preliminary 1-year inflation expectations improved to 5.1% in June from 6.6% in May. While we expect no firm guidance from the Fed on Wednesday, this should make it easier to think about further rate cuts towards fall this year.

In the euro area, industrial production data for April showed a steep decline of 2.4% m/m following a gain of 2.6% m/m in March. The decline was larger than consensus expectations of -1.7% m/m. However, the decline was mainly due to volatile Irish production numbers, and excluding Ireland, production merely declined by 0.7% m/m in the euro area after rising 1.1% in April.

In Sweden, Friday's inflation figures aligned with the preliminary estimates. The CPI figures were 0.1% m/m and 0.2% y/y, while CPIF excl. energy stood at 0.2% m/m and 2.5% y/y. Looking at the details, the effect from the temporary increase in tax deductions for home improvements was -0.2 percentage points. Adjusting CPIF excl. energy for this effect, the data print closely matched the Riksbank's forecast.

Equities: Friday's session was at first glance a textbook example of risk-off driven by a geopolitical escalation. Equities sold off sharply across both sides of the Atlantic, with cyclical sectors underperforming defensives. The VIX moved decisively higher, while energy equities stood out as notable outliers—helped by surging crude prices in anticipation of worsening geopolitical tensions. But beneath the surface, an important divergence. Despite the broader risk off, we did not see a flight to safety in Treasuries but instead we saw a sell-off! In the US equity markets on Friday, Dow -1.8%, S&P 500 -1.1%, Nasdaq -1.3% and Russell 2000 -1.9%. This morning, Asian markets are mostly higher. European equity futures are pointing lower while US once marginally higher.

FI and FX: The Iran-Israel conflict led to a worsening of the market risk sentiment on Friday, with the MSCI ACWI closing down by 1.1%. Over the weekend, Israel has targeted Iranian energy facilities, and this further increases the risk of a lasting oil market shock due to the conflict. Oil prices are slightly higher morning with Brent trading at USD75/bbl as a result. Market-based inflation expectations are also moving up, putting upward pressure on nominal rates across regions. The USD has broadly rallied across G10 since Friday, likely supported by the spike in oil prices given the US's position as a net energy exporter. Likewise, EUR/NOK continues to move lower, now trading at 11.43. Asian equity indices are slightly higher this morning following the stronger-than-expected retail sales data out from China.