Iran/Israel conflict hits risk sentiment yet again, as all eyes towards the Fed

It is difficult to sum up the general mood in the markets on Tuesday. European stocks are extending losses as we move through the European morning session, and US equity market futures also point to a lower open. The oil price is also extending gains towards $74.50, as risk aversion takes hold once more. However, the gold price is only moderately higher. Headline risk from the Iran/ Israel conflict is once again impacting financial markets, after taking a reprieve on Monday.

Stocks are lower after Donald Trump’s abrupt departure from the G7 to monitor events in the Middle East from the White House. This suggests that things could be about escalate in this conflict.  The French President initially said that President Trump was leaving due to a ceasefire between Iran and Israel, but that was rebuffed by President Trump. This has spooked financial markets on Tuesday morning.

Why Oil price gains could still be capped

Since the start of last week’s attacks between Iran and Israel, the price of Brent crude has risen by $6 per barrel. This is a moderate gain considering the stakes in this conflict are high, however there is some logic in the oil market’s restraint. So far, there has been no impact on oil exports, and the strait of Hormuz is still open for oil tankers. This means that one fifth of the world’s oil supply is still flowing through the strait. Oil inventories are rising, and Iranian oil supply has not impacted by the conflict, this is why upside for the oil price could be limited on Tuesday, and gains could be capped around $75 per barrel for Brent crude.

US oil supply and Opec+’s production increases mean that conflict in the Middle East does not always trigger significant upward pressure on the oil price. However, if there was a big escalation in the conflict or if there is regime change in Iran, the oil price could be vulnerable to another pop higher.

UK – US trade deal fails to boost the Pound

The other big news overnight was the US-UK trade deal announced before Trump departed the G7 meeting. This is a coup for the UK. Tariffs will be 10% for auto exports to the US and aerospace exports will not be subject to tariffs. This is the first trade deal the US has signed since the Liberation Day reciprocal tariff announcement. Although this is good news for the UK, aluminum and steel exports are currently still subject to 25% tariffs, although the US Commerce Secretary is working on putting in place a quota system for steel and aluminum exports, which the UK hopes will be generous.

Although UK stocks are lower on Tuesday, they have been saved the worst of the sell off, and the FTSE 100 is outperforming European indices. However, gains have been driven by the energy sector, with BP and Shell both rising by more than 1%. The FTSE 250 is also benefitting from the deal and is outperforming the blue-chip index so far this morning. The pound has failed to benefit from the trade deal, and it is the weakest currency in the G10 so far on Tuesday. UK bond yields are rising in line with European yields so far today.  

The BoJ weighs on the Yen

The yen is one of the weakest currencies in the G10 FX space on Tuesday, even though Japanese bond yields are rising. The Bank of Japan left interest rates unchanged when they met earlier today, and the governor’s press conference was neutral. Although 2-year Japanese bond yields are rising back towards their high from April, the interest rate futures market seems unconvinced that the BOJ will hike rates again this year. There is less than one hike priced in for the BOJ for the rest of this year, and the outcome of today’s meeting is not causing the market to rush to price in rate hikes from the Bank of Japan, which is weighing on the yen.

USD/JPY is also starting to make a comeback. It has risen back above the 50-day sma at 144.00, which is a short-term bullish signal for this pair, and suggests that the yen is vulnerable to a correction and erodes its status as a safe haven currency even further.

What to expect from the Fed

Elsewhere, the focus on Tuesday is event risk from the Iran/ Israel conflict, after Donald Trump said that something ‘big’ was about to happen. Added to this, the market will be looking ahead to Wednesday’s Fed meeting. The Fed is unlikely to commit to rate cuts, and the upside risks to the oil price are likely to reinforce their message that they remain data dependent and will take a cautious approach to future rate cuts.

There is currently no chance of a rate cut priced into the market for tomorrow’s Fed meeting. There are less than 2 rate cuts priced in for the US for the rest of this year, however, tomorrow’s updated Dot Plot from the FOMC could cause movement in the US interest rate futures market. The median expectation from March was for rates to end 2025 at 3.88%, current market-based expectations are for US rates to end the year at 3.84%. Thus, the Dot Plot will need to show a big shift to the upside or the downside to have an impact on stocks, bonds and the dollar, in our view.