Week Ahead: All but Oil, Nonplussed over the New Phase in Israel-Iran War

[Redator]

The Israel-Iran war continues, but outside of oil, the capital markets have barely reacted. WTI rose by about 2.7% last week after a 13% rally the previous week. It reached levels not seen since early January. The average retail price of unleaded gasoline has risen by almost 2.5% this month. The price of gold fell by nearly 2% last week, its first weekly decline in three. The dollar rose against all of the G10 currencies. The US tariff threats, with postponement of the so-called reciprocal tariffs coming to an end on July 9, continue to cast a long shadow. The last-minute scramble for deals has begun. The recent doubling of the US steel and aluminum tariffs to 50% seem to make things more complicated. Meanwhile, US real sector data continues to surprise on the downside, and that includes last week's reports on May retail sales, industrial production, and housing starts. Still, the FOMC indicated it is no hurry to change policy, and despite Governor Waller, who is thought to be one of the candidates to succeed Chair Powell, suggesting before the weekend that a July cut is possible, the market does not believe it. September is a different story and Fed funds futures are discounting around a 80% chance of a cut then. 

With the Russia's war in Ukraine continuing and the new phase in the Middle East war, NATO has much to consider when it meets at the start of the new week. President Trump has said he will decide about increasing the US role against Iran in the next two weeks, by which time, Israel's operation will be over or nearly so. Some reports (e.g., Guardian) that Trump is not yet convinced that the "bunker buster" bomb would be sufficient to eliminate the Fordow enrichment site even if it could inflict damage. The penetration depth is estimated to about 200 feet (61 meters) and the Israeli intelligence estimates the facility may be as much as 300 feet below the surface. Meanwhile, the economic diaries are fairly light in the week ahead. The flash PMI starts the new week. US CPI and PPI have stolen the thunder from the PCE deflators. Tokyo's June CPI is expected to moderate slightly. Mexico's central bank is expected to deliver another 50 bp cut, but with inflation above the target band, a quarter point cut may be a compromise. 

US

Drivers:  Before the President Trump's inauguration in January, the conventional wisdom was that the dollar would strengthen on rising US tariffs. That has not proven to be the case, and what is more, the greenback appears to weaken when tariff threats are elevated. The end of the postponement of the so-called reciprocal tariffs is early July, and ahead of it, Trump has said he would send letters to countries, announcing the new bilateral tariffs. Separately, it seems as if higher rates did not help the dollar, but lower rates weigh on it. The new phase in the Israel-Iran war can become more impact for the dollar if the US takes a more direct role or if the war widens. The cost of insurance may be slowing activity in the Gulf of Hormuz more than Iranian forces. 

Data: Given Fed officials’ recent comments, the market has little reason to react much to the survey data in the coming days, which include the preliminary PMI, several regional Fed surveys, and the Conference Board's measure of consumer confidence. Given the tariffs, the May goods trade balance will be of interest. Weekly jobless claims will also draw attention given the recent rise in the four-week moving average to the highest since August 2023 and the elevated continuing claims. Meanwhile a surge of orders for Boeing (303) in May will lift durable goods orders after a sharp 6.3% decline in April. The 1.5% decline in April orders excluding aircraft and defense was the largest drop since February 2023. Lastly, personal income and consumption data will help fine-tune Q2 GDP forecasts, which the Atlanta Fed says is tracking 3.4% and the median projection by economists in Bloomberg's survey is 1.4%. Details for the CPI and PPI suggest the PCE deflator will tick up to 2.3% from 2.1% at the headline level and 2.6% from 2.5% at the core level. 

Prices: The Dollar Index consolidated last week at somewhat firmer levels. It traded above the down trendline from the May 12 high (~102.00) and the late May high (~100.50) and June 18 high (~99.00) and settled above it last week. The trendline begins the new week near 98.65. The momentum indicators suggest a consolidative/corrective phase may be at hand. The five-day moving average looks poised to cross above the 20-day moving average in the coming days. The initial target may be in the 100.00-50 area.  

EMU

Drivers: The euro benefits from being the un-cola to the dollar's Coca-Cola. It is the most liquid alternative to the greenback. With encouragement from ECB officials, the market believes the central bank's easing cycle is nearly over. After a pause in the coming months, the swaps market is pricing in one more cut before the end of the year, which would bring the deposit rate to 1.75%. That has been identified to be around the neutral rate (r*). 

Data: The markets may be more sensitive to the eurozone's PMI than the US because officials seem to give it more weight. The composite PMI slipped in April and May, reinforcing the sense that the best EMU growth may be behind us. May auto registrations, a proxy for sales are due. April showed the first increase year-over-year here in 2025. They rose 1.3%. Germany's June IFO is due. The assessment of the overall business climate (current conditions and expectations) has risen every month this year, already surpassing 2024, when there was improvement in four months. 

Prices: The euro pulled back from $1.1630 reached on June 12, the highest level since October 2021. It recorded a low, a week later, near $1.1445, and found support slightly ahead of the 20-day moving average, which it has not traded below since the end of May. Nearby resistance is seen in the $1.1550-60 area and the euro stalled in front of it ahead of the weekend. A consolidative/corrective phase can continue if the resistance holds. On the downside, a break of $1.1440 could see $1.1380 initially. 

PRC

Drivers: China maintains a firm hand managing the yuan. The yuan does not appear particularly sensitive to high frequency data or news developments. Beijing is committed to maintaining the broad stability of the yuan against the dollar. It has introduced a modicum of more flexibility in the slightly greater change in the daily fix. China's economy is struggling to sustain the momentum necessary to achieve its growth target and deflation continues to grip. In such a macro setting, a stronger yuan, simply because of the dollar's decline, may not be helpful. 

Data:  China reports industrial profits. There was a press article recently about the percentage of Chinese companies that are recording losses, but it is a dog-bites-man story. Chinese numbers only appear high if an international context is not provided. Moreover, contrary to conventional wisdom, companies in market economies do not all compete to maximize profit. Some compete for market share. In comparative economic literature (see Varieties of Capitalism), the former was associated with countries in which markets were the main channel of capital distribution (stock and bond markets). The latter were associated with bank-led capitalism and was dubbed the "Rhine model" by the authors. 

Prices: The PBOC has been steadily lowering the dollar's fix in recent weeks. Given that the greenback is allowed to trade only 2% above the reference rate, the decline in the fix lowers the dollar's cap. Before the weekend, the fix was set at its lowest level in three months (CNY7.1695). The setting of the daily reference rate is among the most powerful tools at Chinese official disposal to manage the exchange rate. Since earlier this month, the greenback has been consolidating between roughly CNH7.1650 and CNH7.2000. 

Japan

Drivers: The yen's sensitivity to US interest rates has increased over the last few weeks. The rolling 30-day correlation of changes in the exchange rate and the US 10-yer yield has risen to 0.48 from slightly below 0.10 a month ago. The Israel-Iran conflict did not spur a safe haven rally in the yen. One explanation is that many viewed it primarily through the prism of an oil shock. Japan has the highest inflation in the G10, but the central bank is clearly reluctant to hike rates. Its bond and equity markets are the worst performing in the G7 so far this year. 

Data:  Japan sees the latest employment figures and retail sales, but arguably the most important report is the Tokyo's June CPI. It leads the national figure by several weeks and is fairly good predictor. Bank of Japan Governor Ueda rhetoric has been toned down. To be sure, he still maintains that if the economy evolves as the central bank expects, it will continue to raise rates. However, he also argues that the inflation target has not been achieved. The swaps market sees the year-end target rate at almost 0.60%, down about 25 bp since late March. 

Prices: The dollar posted its biggest weekly advance of the year against the yen, almost 1.40%. It set the high for the month before the weekend, slightly above of JPY146.20. A move above the JPY146.30 area could spur a move toward JPY147.00-15 next. The momentum indicators are constructive. Initial support may be around JPY144.35, though the pre-weekend session was the first since May 14 that the dollar did not trade below JPY145. 

UK

Drivers: Sterling's 7.6% gain this year against the dollar largely reflects the greenback's weakness rather than strong UK attractors. The swaps market has turned less dovish. The year-end base rate is anticipated to be near 3.75%, up from around 3.50% at the end of April. The swaps market sees the year-end effective average Fed funds rate near 3.75%, up around 50 bp since the end of April. Still, sterling has risen by around 1.8% in the same period. 

Data: The UK takes another look at Q1 GDP, when its 0.7% quarterly expansion put it atop the G7. Growth is off to a poor start in Q2, with the April GDP contracting by 0.3%, the largest monthly decline in output since October 2023, and May retail sales, reported before the weekend, fell 2.7% (the median forecast in Bloomberg's survey was for a 0.5% decline), more than offsetting the 1.3% increase in April. The April composite PMI was 48.5, which matched the lowest since November 2022. It recovered to 50.3 in May. The preliminary June reading will be released this week.

Prices: Given the downside surprises of the UK data, and the dovish hold by the Bank of England (6-3 vote), sterling held up fairly well. Its 1.1% loss on June 17 after the GDP miss was the largest loss in a little more than two months. It made a marginal new low before the outcome of the BOE meeting on June 19 near $1.3380 and recovered to trade above $1.3500 before the weekend, where it met sellers who knocked it back to around $1.3440  to record new session lows in late dealings. A break of $1.3380 could see another half-cent decline in short order. The five-day moving average slipped below the 20-day moving average for the first time since May 19. Initial resistance is seen in the $1.3480 area.  

Canada

Drivers: Sometimes, the Canadian dollar seems sensitive to the risk-climate and sells off alongside US S&P 500. Sometimes, the Canadian dollar seems sensitive to interest rate developments. Now the Canadian dollar seems most sensitive to the US dollar's broad direction. The 30-day correlation between changes in the exchange rate and the Dollar Index is slightly above 0.70. It has rarely been higher in the last several years. To put it in some context, consider that in February, the rolling 30-day correlation was below 0.20, the lowest since the end of 2021. 

Data: Canada reports May CPI. Recall that in April, the headline rate fell to 1.7% from 2.3%, but the rise in the underlying core rates was cited by the Bank of Canada in its decision to standpat. Given this reaction function, the market will also put emphasis on the core readings. Canada also sees April GDP. The economy expanded by 2.2% at an annualized rate in Q1, but economists warn of a contraction in the second quarter (-1%), so a poor April GDP print would not be surprising. February GDP fell by 0.2% before a 0.1% expansion in March. Still, the Bank of Canada has indicated that its easing cycle is nearly over, and the swaps market has one more cut discounted at the end of the year. 

Prices: The US dollar fell to its lowest level since last October (~CAD1.3540) at the start of last week before recovering. It made a marginal new high for the month before the weekend, slightly below CAD1.3750. The greenback finished the week above its 20-day moving average (~CAD1.3700) for first time since May 20. The five-day moving average looks set to cross above the 20-day moving average in the coming days. Near-term potential extends toward CAD1.3780-CAD1.3800. Above there, the CAD1.3835-60 area beckons. 

Australia

Drivers:  The Australian dollar rivals the Canadian dollar with the dubious honor of being the weakest performer in the G10 this year. The Australian dollar has risen by about 4.35% while the Canadian dollar has appreciated by about 4.80%. The Australian and New Zealand dollars were the heaviest of the G10 currencies when Israel first struck Iran on June 13. The rolling 30-day correlation between changes in the Australian dollar and the Dollar Index is near 0.75, the upper end of where it has been since the middle of last year. The 30-day correlation with the Canadian dollar is near 0.60. The 30-day correlation with gold has slipped below 0.40, its weakest since early April. 

Data:  Australia sees the preliminary PMI, but the market does not seem to place much importance in it. The May CPI in the middle of the week will likely draw more attention. It has been steady at 2.4% for the previous three months. The central bank still appears to put more weight on the quarterly reading. Barring a significant surprise, the Reserve Bank of Australia is seen cutting rates again when it meets early next month. The futures market has about an 80% chance of a cut discounted, and almost two more before the end of the year, which means it is seen as among the most aggressive G10 central banks after a belated start. 

Prices: Disappointing May employment data, the second overall monthly job loss of the year, and an unexpected decline in the participation rate saw the Australian dollar sold to a two-and-a-half-week low near $0.6445 on June 19. It steadied, though stalled near $0.6500 before the weekend and returned to lows. The momentum indicators are softening, and the five-day moving average looks poised to push below the 20-day in the first part of the new week. On balance, the takeaway is the corrective/consolidative phase does not appear over, and the low for may not be in place. Support may be in the $0.6400-$0.6425 band. 

Mexico

Drivers: The peso is up an impressive 9.4% against the US dollar this year. This has outstripped the MSCI Emerging Market Currency Index (~6.0%) and the JP Morgan Emerging Market Currency Index (~7.2%). It has also outperformed half of the G10 currencies. This is particularly impressive given the less-than-friendly US policies that seem to undermine Mexico's developmental strategy, which includes investment by foreign companies (including and especially US companies), remittances from Mexican workers employed in the US, and tariffs on steel and aluminum, despite the USMCA, which was negotiated in President Trump's first term. Moreover, Mexico's policies are not seen as particularly investor-friendly, and the popular election of all judges was seen by many as politicization of the judiciary. Still, the peso benefits from being the long leg of carry trades against the dollar, its low volatility and liquidity. Still, the price action shows that risk-off in the extreme, like when Israel struck Iran, the peso is sold, partly, perhaps, in its own right, and partly as a liquid proxy for other emerging market currencies. 

Data:  Before getting to the highlight of the week, the central bank meeting on Thursday, June 26, Mexico report April retail sales and IGAE economic activity report, the first half of June CPI, and May trade figures. Despite the slugging economy, Mexican retail sales rose by an average of 0.5% a month in Q1 25 after falling by an average of 0.6% a month in Q1 24. The IGAE is like a monthly GDP estimate. It finished Q1 on a weak note, with a 0.36, decline. Price pressures have been edging higher, and both the headline and core rates likely remained over 4%, the upper end of the target range. Mexico has recorded a trade surplus of about $1.26 bln in the first four months of the year compared with a $6.45 bln deficit in the Jan-Apr 2024 period. There have been conflicting signals from Banxico's leadership about this outlook for this week's meeting. A compromise would be a quarter-point cut that would bring the target rate to 8.25%, but economists favor a 50 bp move. 

Prices: The dollar made a marginal new low against the Mexican peso to start the week near MXN18.8250. It trended higher from there and reached almost MXN19.19 before the weekend. It posted its highest settlement since the end of May. The 20-day moving average is near MXN19.13 and the dollar settled above for the first time this month. Momentum indicators are moving higher. The greenback could test 19.25 area and a push above there could signal a re-test of the month's high, near MXN19.45. 

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