Hope And Reality

By Teeuwe Mevissen, Senior Macro Strategist at Rabobank

Since the start of the Iran war the market has had a tendency to view the likelihood of a peace agreement with a ‘glass half full’ attitude.

Once again, markets have found some comfort in encouraging remarks from both the US and Iran, even though both sides are making it clear that there are still major sticking points on critical issues.

US Secretary of State Rubio has suggested that there are “some goods signs” towards finding a resolution. This is despite Iran’s Supreme leader ordering that the country’s enriched uranium must not be sent abroad, which is a key objective of both the US and Israel. Rubio has also stated that any deal that involved Iran imposing tolls on shipping passing through the Strait of Hormuz would be unacceptable. This statement comes on the heels of this week’s news that Iran is looking to set up a new “Persian Gulf Strait Authority” to exert control over a maritime zone in the area and that the country’s authorities are also discussing with Oman how to set up a permanent toll system. Amid the confusion over the degree of progress towards peace, Brent crude prices have ticked higher this morning, though they remain in the lower part of this week’s range.

Reflecting movements in oil prices, US treasury yields are also trading in the lower part of this week’s range, though they remain at elevated levels. While asset prices continue to take their cue from speculation regarding the length of time that the Strait of Hormuz may be closed, economic data are increasingly reflecting the impact that the supply shock is already having.

Yesterday’s release of French preliminary May PMI data showed a plunge in the composite number to 43.5 from 47.6 the previous month, with weakness evident in both the manufacturing and the services sectors. The composite number, which is a 66-month low, would usually be associated with recession.

According to S&P Global, firms cited higher fuel and energy costs as reasons for lower output, with manufacturing firms citing material shortages.

The German PMI data was less of a shock but with a composite number reading 48.6, the economy is continuing to show signs of contraction. While this morning’s German IFO release was a little better than expected, it remains close to a 5-year low.

Yesterday’s release of the spring forecasts from the European Commission reflected the growing pessimism regarding the economic toll of the Iran war. GDP growth in the EU is now projected to slow to 1.1% in 2026, a downward revision of 0.3 ppts from the autumn forecasting round.

Growth for the Eurozone this year is now projected to be just 0.9%, while price pressures have been revised higher. The EC’s forecast for inflation in the EU has been revised a full percentage point higher to 3.1% in 2026. The forecast for the Eurozone stands at 3% this year up from an autumn forecast of 1.9%.

The data highlight the conundrum for the ECB. Price pressures are of clear concern, but weak activity data question whether the ECB needs to hike rates as much as markets have been expecting to rein back demand in the face of the supply shock. This morning the market is priced for a little more than two 25 bps ECB rate hikes on a 6-month view. Rabobank has pencilled in just one for now.

How weakening economic activity will impact central bank decisions has been a theme in many parts of the G10 this week. The releases of softer than expected UK and Australian labor data earlier in the week had a noticeable impact on rate hike expectations in their respective markets. Weak UK retail sales data this morning have further shone the spotlight on growth risks.

Cost of living pressures have been highlighted by UK voters as a primary concern and PM Starmer’s leadership continues to hang by a shoestring. In an effort to grapple back some control, the (current) Labour party leadership have this week announced steps to ease pressure on household budgets. This includes extending a freeze on fuel duty, cutting VAT on some hospitality services over the summer, and granting a 12-month road tax holiday for hauliers.

The package of measures will be funded by bringing forward changes to how oil and gas companies are taxed on overseas earnings. UK Chancellor Reeves’ adherence to her fiscal rules have won her some credibility in the gilts markets. Concerns that a leadership challenge would result in a swing to the left of the party and bring more spending pledges have unsettled the gilts market this month, though comments earlier in the weeks from Manchester Mayor Burnham that he would maintain the fiscal rules if he led the country have provided some reassurance.

Burnham may be the bookies’ favorite for the next leader of the UK’s Labour party, but he must win a seat in parliament before announcing a challenge. The most likely date for the Makerfield by-election is June 28. Reform will be fighting hard to win that seat ahead of Burham.