• Stocks pull back, oil climbs as Iran escalates tensions with UK
  • Dollar outperforms after Fed’s Bullard downplays prospect of ‘double’ cut
  • Big week for euro, with a crucial ECB meeting on Thursday

US equities retreat, oil rebounds after Iran seizes British ship

Geopolitical headlines rattled markets late on Friday, with the benchmark S&P 500 (-0.62%) closing in the red after Iran seized a British oil tanker in the Strait of Hormuz, escalating hostilities with London to a new level. Oil prices naturally moved higher, as the sizzling tensions likely raised the perceived likelihood that this conflagrates into a ‘hotter’ conflict, disrupting crude supply in the Gulf.

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The situation remains fluid and unpredictable – but in a sign that all hope may not be lost just yet, separate reports suggest US Senator Rand Paul met with Iran’s Foreign Minister last week in an attempt to defuse the tensions. In fact, the Senator said there might be an opening for Iran to sign an agreement that it “won’t develop a nuclear weapon, ever”. This shows that a diplomatic solution is still possible, though admittedly, further escalation seems more likely before – and if – we reach the negotiating table.

For now, how harshly Britain responds may be key for risk sentiment, especially since this will be the first ‘test’ for the new Prime Minister, who will be announced tomorrow.

Fed arch-dove Bullard reins in expectations for aggressive July cut

The dollar outperformed on Friday, aided by the New York Fed walking back some dovish comments from its President, but also by some remarks from the St. Louis Fed chief – James Bullard. He said in no uncertain terms that he would like to cut rates by 25 basis points (bp) in July, and not by 50bp as markets have been speculating.

This is especially important coming from Bullard, as he may be the most dovish FOMC member, having voted for an immediate rate cut in June. He was also opposed to raising rates last year. The point is that if a dove like Bullard isn’t onboard with a ‘double’ rate cut in July, then there’s little scope for that to happen. Since markets still price in a ~20% chance for a 50bp cut, the path of least resistance for the dollar may be higher over the next couple of weeks, especially if the GDP stats on Friday are solid.

All eyes on the ECB in decisive week for euro

The economic calendar is almost empty to start the week, without any major releases before the latest euro area PMIs on Wednesday. Then, the European Central Bank (ECB) will meet on Thursday and investors will be hanging on Draghi’s lips as they try to decipher how aggressive a stimulus package the central bank will deliver in the coming months.

The euro’s short-term fortunes will therefore hang in the balance. Markets are already pricing in almost 20bp of ECB rate cuts by December, so for the single currency to weaken from here, the ‘maestro’ would need to signal that an even bigger easing package is in the works.

German press is reporting that the ECB plans to restart its QE purchases in November according to sources, and if Draghi endorses such expectations, that could definitely be enough to send the euro lower.

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