The standoff between the US and Iran shows little sign of abating, after President Trump dismissed Tehran's response to peace overtures over the weekend.
Markets are starting to adapt. Oil prices remain high, but have eased lately due to a combination of demand destruction and increased production elsewhere. US stocks continue to print at fresh highs, as European equities lag, and the dollar appears to have resumed its gradual descent against most currencies. The key EUR/USD pair is now bumping against its pre-war levels, and some emerging market bellwethers like the Brazilian real are significantly higher over the period.
With war negotiations proceeding slowly and painfully, the focus should shift back to the effect of the Hormuz closure on the real economy. The most critical issue is whether the direct impact of the energy price spike will spill over into more general pricing pressure. The April inflation report out of the US on Tuesday will offer one of the first direct looks at the problem. Economists expect only a modest rebound in the core sub-index, but uncertainty is high. Bond markets worldwide are jittery and only have limited patience for negative inflation surprises. A slate of March production data out of the UK and the Eurozone will round out the week's macroeconomic events.
USD
The April nonfarm payrolls data was the latest in a line of economic reports to suggest that the US economy is so far almost entirely unaffected by the Iran war and resulting energy price spikes. Job creation rebounded, and the three month average of 48k net jobs per month is inconsistent with labour market loosening, given that the labour force is no longer growing due to the immigration crackdown and ageing population. This merely confirms the message from the weekly jobless claims, which have actually been falling lately.
The feared AI-related job apocalypse doesn't seem to be materialising, as employers are largely seeing it as more of a supplement, rather than a replacement, for staff. However, the good economic news was little help to the US dollar last week. As we have seen for the last year, somewhat paradoxically, relatively strong economic data out of the US appears to be fully compatible with a depreciating greenback.
GBP
The pound has weathered the results of the May local elections in the UK remarkably well, in part as the Labour bloodbath was roundly expected and priced in by markets. Investors are betting that Labour's overwhelming defeat will not end Starmer's premiership just yet, but pressure on the prime minister looks set to intensify in the coming days, with a number of backbenchers already calling for his resignation. As this is written, no potential rivals on his left have launched a formal bid to replace him, although there are murmurs that the likes of Rayner and Streeting are privately weighing their options.
A potential lurch to the left is what markets fear most, as this could mean higher taxes, heavier gilt issuance and a broader fiscal risk premium baked into UK assets. Meanwhile, macroeconomic data has generally surprised to the upside, though economists question whether this relates to post-COVID statistical quirks in the seasonality of the data. This week’s monthly GDP report for March therefore takes on added importance.
EUR
ECB commentary has taken a hawkish turn of late, with most council members emphasising the need to be vigilant against second-round effects originating from the energy price spike. Expectations of a hike at the next meeting in June keeps building, and the contrast with the Federal Reserve’s hesitation is closing the interest rate gap across the Atlantic. This will be a key source of support for the euro in the medium term, and we expect the gradual dollar depreciation to continue into 2027.
In the near-term, the euro remains highly susceptible to the conflict in Iran, which is already having a disproportionately negative impact on the Euro Area economy - the April PMIs show an economy that is in contraction. Upcoming peace talks will, therefore, be critical for EUR/USD. News of a temporary peace deal could see further gains for the common currency, although we see plenty of room for downside should negotiations break down given that a lot of good news already appears to be priced in by markets.
CNY
The yuan, which tends to closely track the greenback, underperformed most of its EM peers last week. Domestic data was encouraging, however. The RatingDog services PMI outperformed in April, as did the manufacturing index, lifting the composite number to 53.1 from 51.5. More importantly, export data was noticeably stronger than expected – deliveries jumped 14.1%, contrasting sharply with the previous, disappointing month. The AI boom is lending exports a boost, but they were also supported by stockpiling amid the Iran war(that is also supporting the business activity data).While the coming days are set to bring a handful of noteworthy releases, most of the attention this week will be on President Trump’s visit to Beijing for the 14-15th May summit with China’s Xi Jinping. Given that the US war in Iran further complicates the relationship between the two countries, and might work to weaken Trump’s negotiating position, the meeting is set to be of even greater importance. Rapid advances in AI, and the risks they entail, are yet another reason the relationship needs to be carefully managed.
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