Too early to price out the war

The US sent a 15-point plan to Iran to end the war, which Iran publicly refused. They proposed alternative conditions instead and continued attacks in the region.

Interestingly, equity investors bought into the US 15-point peace plan and hardly reacted to Iran’s rejection. The S&P 500 rose 0.54% yesterday. Despite trade and geopolitical uncertainties, analyst estimates for S&P500 earnings may have improved since the start of the war, according to Bloomberg Intelligence. Expectations for profit growth rose from 10.9% to 11.9% since the beginning of Middle East hostilities, narrowing the margin for disappointment and increasing the risk of a sharper correction.

The index met resistance at the 200-DMA, while US crude jumped 4%.

Oil is higher again this morning, with Brent crude preparing to regain the $100pb handle. Asian equities are down, while US and European futures point to a lower open. Investors are trying to price out the war and price in a peace rally ahead of time. But risks remain elevated and downside risks prevail.

Donald Trump insists that peace negotiations are ongoing, describing developments in the Middle East as “big”, but he is no longer controlling the narrative. One of Iran’s senior military figures mocked the US, saying: “Has the level of your inner struggle reached the stage of you negotiating with yourself?” This reflects where we stand in negotiations.

That said, Trump appears eager to end the war as political and geopolitical pressure builds into the midterm elections. Deutsche Bank has even created a “pressure index” incorporating factors such as the one-month change in Trump’s approval ratings, stock market performance, and inflation expectations derived from bond markets. That index is now at its highest level since his election.

And the economic pressure is spreading beyond oil prices. US mortgage rates, for example, have returned to their highest levels since October, weighing on new purchase applications. These rates are driven by the US 10-year yield and a risk premium—both of which have risen since the start of hostilities, alongside oil prices, inflation expectations and US debt concerns. The US 10-year yield has risen by as much as 50bp from its early-month lows, as investors shifted from pricing in summer rate cuts to considering the possibility of rate hikes later this year and more military spending in the coming years. Fed funds futures currently imply around a 30% chance of at least a 25bp hike by year-end. But note that this could change rapidly as stagflation risks also rise.

In FX, the US dollar appreciated yesterday and remains slightly bid in Asia. The EURUSD and Cable are both under pressure despite increasingly hawkish expectations for the European Central Bank (ECB) and the Bank of England (BoE). In Europe, ECB President Christine Lagarde said the bank “will not be paralysed by hesitation” in responding to the energy shock from the Middle East war. In the UK, hotter-than-expected inflation data—partly reflecting earlier declines in energy prices—suggest that the energy shock could materially shift the inflation trajectory and force a policy response.

In Westminster, Rachel Reeves indicated plans to accelerate power plant construction, aiming for projects to come online by the end of 2027... a bit ambitious!

Global X Uranium ETF rose 1.58% yesterday but has declined since the start of the war, despite European pledges to return to nuclear energy. The medium- to long-term outlook remains positive, and current levels could attract buyers back into the market.

Elsewhere, gold reversed the past two sessions’ gains in Asia this morning, falling more than 1.5% as optimism around a Middle East peace fades. Other metals, including silver and copper, are also under pressure from a stronger US dollar, higher yields and deteriorating global growth expectations, as the war risks extending beyond a month.

Commodities and TIPS remain effective hedges in an inflationary environment, but uncertainty is currently so high that cash is king—and in practice, that often means the US dollar.

Once the dust settles, however, the hawkish divergence between European and other major central banks relative to the Fed could cap further dollar appreciation. The US dollar and Treasuries have been losing their international appeal due to erratic trade policies, rising US debt and US’ deteriorating international relations, which are pushing central banks to diversify reserves away from US assets. That longer-term trend is likely to reassert itself. For now, however, the dollar benefits from a lack of credible alternatives. Today’s US 30-year bond auction will be worth watching.

In tech, news flow was mixed. Meta and Google were found liable for harming young users of their platforms and will face fines. However, their share prices were largely unchanged, as the penalties are marginal relative to revenues and investors remain focused on AI, growth opportunities rather than regulatory risks. The primary valuation risk remains delayed returns on heavy AI investment.

That said, AI demand remains strong. Arm Holdings jumped more than 16% after announcing plans to start building its own chips, with potential annual revenue of up to $15bn by 2031. The company has historically focused on chip design for third parties. That said, Arm remains expensive, trading at around 190 times earnings. While new revenue streams may compress that multiple, the stock is unlikely to become cheap anytime soon.