Displaying items by tag: macroeconomics

 The US-Iran Peace Deal Removed One Risk Premium. This Week's Inflation Data Could Decide the Fate of Gold, Silver, Oil, and Stocks

The geopolitical war premium is dead, but the inflation premium is just waking up—and this Thursday’s Core PCE print will mercilessly punish portfolios still positioned for last week's headlines.

The initial reaction of the market on Monday's ‘Peace Deal’ between Iran and the United States was quite simple. The oil prices went down due to the elimination of the geopolitical risk premium, which existed since February. The stock indexes went up thanks to improved sentiment. At first, gold rallied to $4,334/oz, but then reversed significantly.

But by the end of Friday's trading session, the price action in the majority of asset classes showed that institutional investors stopped trading the famous peace deal. The capital flow turned more toward another key theme – will the easing of tensions translate to a meaningful drop in inflation as the Federal Reserve explicitly said it is preparing to raise rates.

It's an important distinction. The diplomatic agreement has physical implications for the energy supply, but the final rate of the Fed will have implications for the valuation framework for all asset classes. The diplomatic story will be replaced by Thursday's inflation print for the this week.

A Week was Influenced by Two Major Factors

Washington and Tehran were able to eliminate the war premium from commodity markets through the agreement. The impact was immediately obvious and was easily seen in global crude benchmarks.

Over the last 5 days, the price of Brent crude fell from $81.00 to $79.59 per barrel. It took place despite the abrupt end of follow-up negotiations in Bürgenstock, Switzerland. But much more important than that: physical reality overrode the political news. Kuwait officially announced increased production plans and the normalizing of the traffic through the Strait of Hormuz. Typically, in such a climate, the end of the negotiations in Switzerland would lead to a sharp increase in crude prices. But it didn't happen. This price action underscores that traders are beginning to listen to freight data, not diplomatic press conferences.

Meanwhile, another much more significant factor emerged. The first policy meeting chaired by Fed Chairman Kevin Warsh on Wednesday brought a historical hawkish surprise. Although the FOMC decided to hold the federal funds rate at 3.50%–3.75%, the new dot plot shows that nine out of nineteen policymakers expect an additional tightening later this year.

Warsh emphasized this by releasing a brutal statement of 130 words without any forward guidance. This resulted in a significant re-pricing of almost all assets. The Fed's announcement pushed gold down from $4,360 on Tuesday to $4,228. Real Treasury yields surged, and on Wednesday, Wall Street was responding not to Tehran but only to Washington.

Why Gold and Silver Are No More the Pure Safe Havens

The most complex chart divergence of the week occurred in precious metals. Traditionally, the formal decrease in Middle Eastern tensions should strongly affect gold. However, that downward pressure on the metal was primarily attributed to the Fed.

Now gold is under the influence of two opposite macroeconomic factors:

·         Reduction of the Geopolitical Demand: The safe-haven premium in relation to the Strait of Hormuz has gone.

·         Monetary Uncertainty: The inflation hedge premium is increasing as the Fed signaled that it may have to push the economy into the recession in order to destroy the sticky price pressures.

One more thing to consider about silver. Unlike gold, silver gets about 60% of its demand (about 680 million ounces each year) from industrial purposes. So, silver benefits when the expectations for global economic growth rise even when the safe-haven demand declines.

And if the US-Iran peace deal results in lower energy costs and better industrial growth prospects, then silver may outperform gold significantly despite both metals are facing serious challenges from rising real yields. Moderate geopolitical risk and continuing structural deficit generally are good times for silver, given the influence of industrial demand.

Oil's Next Move Depends on Tankers, Not Diplomats

Crude market has finally shifted from the geopolitical theme to the supply and demand situation. The most critical data for the week is not the signing at Versailles, it's the satellite data.

Due to the normalization of the transit through Hormuz Strait and discussions about output increases among the Gulf producers, the physical disruptions justifying the current $80+ Brent level are disappearing. It's the reason why Brent remained depressed after the Swiss failure, while domestic US WTI rose to $78.15.

·         For oil bulls: The geopolitical risk premium can be removed only once. In order to drive prices up, they must demonstrate that demand for the goods is increasing across the world faster than the new supply of goods from Kuwait.

·         For oil bears: The thesis is entirely evidence-based. Any confirmation of tanker movements and output growth, will be a step to test the structural floor of $75.

This week's daily shipping logs will influence the pricing much more than any political statement from Geneva.

US Equities Face a More Complex Test

This week, equity investors attempted to play both sides of the tape. Lower oil prices will benefit the corporate profit margins, while the peace deal has increased the risk-on attitude of the market. However, Thursday's rally was driven simply by the momentum of semiconductors.

However, the hawkish shift in the Federal Reserve create a challenge in the equities. A persistent drop in energy prices will be bullish only if it will cool the overall inflation. And if this  week's inflation data will confirm that inflation is entrenched in the services sector, immune to the low crude prices, the Fed will hike rates.

The most vulnerable sectors of the equity market are not the large-cap tech stocks hiding the weakness of the index. Investors need to focus on rate-sensitive areas such as regional banks, small caps, represented by the Russell 2000 index, and real estate investment trusts (REITs). These segments are much more specific indicators of actual expectations for real interest rates than the S&P 500.

The Most Important Number of the Week

This week's deciding factor will be the release of the Core PCE (Personal Consumption Expenditures) data for May on Thursday, June 25, which will be the final determination of either of two narratives.

The current consensus has Core PCE rising 0.3% month-over-month and remaining at 3.3% year-over-year.

Thursday's print will dictate whether the market continues trading the peace dividend, or if it officially begins trading a renewed inflation cycle.

Bottom Line

The most dangerous assumption retail investors will make heading into Monday is that the US-Iran agreement is still the primary driver of asset prices. It is not.

The peace deal has already extracted the geopolitical premium from the tape. What happens next depends entirely on whether domestic inflation responds to those lower energy prices. For gold and silver, the question is whether inflation fears outweigh declining war risks. For crude, the focus is strictly on physical tanker flows. For equities, it is a binary bet on the cost of capital.

The answer to all of these questions arrives Thursday at 8:30 AM EST.

Written by: Saman Ali

Disclaimer:
This article is for informational and educational purposes only and does not constitute financial, investment, trading, or legal advice. Always do your own research or consult a licensed advisor before making trading decisions.