Market Brief: US-Iran deal hopes lift global asset prices

Oil prices are falling and risk assets are climbing after signals from both Washington and Tehran suggested the two sides are closing in on an agreement to pause hostilities and reopen the Strait of Hormuz to energy shipments. After President Trump yesterday announced he had cancelled scheduled strikes on Iran, saying the final points of a deal had been approved by all parties, Iran's semi-official Mehr News Agency this morning published a 14-point draft "memorandum of understanding" it said was under discussion with the United States. Both Brent and West Texas Intermediate are down nearly 3%—bringing weekly losses to almost 6%—and Treasuries and equities are rallying as perceived tail risks recede.

According to Iranian media outlets, the memorandum of understanding includes an immediate and permanent ceasefire on all fronts, including Lebanon, along with a lifting of the naval blockade and a reopening of the Strait of Hormuz within 30 days. American forces would withdraw from areas surrounding Iran. On the economic side, the draft calls for a suspension of oil and petrochemical sanctions, the release of $24bn in frozen Iranian assets—half before talks begin—and a US-led reconstruction programme worth at least $300bn. A 60-day negotiation window, conditional on prior sanctions relief and the removal of the blockade, would be used to finalise an agreement on uranium enrichment, broader sanctions relief and the lifting of related UN and IAEA measures. Iran would reaffirm its commitment under the Non-Proliferation Treaty not to build nuclear weapons*. The deal would be backed by a UN Security Council resolution and a monitoring mechanism, while explicitly excluding Iran's missile programme and its support for regional proxy groups from the agenda.

Caution is warranted. An imminent deal has been announced at least 38 times in the past three months, and this one may prove no more durable. Negotiators remain far apart on nuclear issues — enrichment suspension and the fate of Iran's highly enriched uranium stockpile have been deferred to a follow-on accord — meaning the 60-day negotiation window could bring further reversals and potentially a re-escalation in military activity. Israel is not a party to the agreement and has not signalled a willingness to halt its campaign in Lebanon. There are also domestic obstacles: Trump may struggle to present the deal as a victory, given that it bears a striking resemblance to the pre-war status quo—in particular, to the Joint Comprehensive Plan of Action signed under the Obama administration—making it difficult for him to follow through on American commitments.

However, even a temporary reopening of the Strait of Hormuz could ease the inflation shock facing global central banks, allowing markets to price in more modest tightening trajectories. A sustained drop in energy prices would see traders pull back on bets that the Federal Reserve delivers a hike this year — in theory eroding the US yield advantage. But the repricing would be far more dramatic in Canada, the euro area, the United Kingdom and Japan, where monetary-policy expectations had ramped up despite soft underlying economic conditions. To some extent this is already underway, with rate expectations moving down across the major economies this morning, most sharply in energy-sensitive blocs.

In currency markets, reaction has been subdued, reflecting a broad reluctance to place directional bets against a deeply uncertain geopolitical and economic backdrop. The pound is trading flat after the British economy contracted -0.1% in April, solidifying expectations for a hold at next week's Bank of England meeting. The euro showed no visible reaction to yesterday's rate hike from the European Central Bank***. And the yen is holding firm just below the 160-per-dollar threshold, with the threat of intervention offsetting sustained selling pressure to keep the exchange rate rangebound. Across the major currency pairs, measures of implied volatility remain remarkably low.

Here in Canada, the exchange rate is flirting with the 1.40 threshold. With the economy facing sustained headwinds and the Bank of Canada signalling an intention to look through the energy-price shock, two-year rate spreads between the US and Canada remain tilted against the loonie. We think markets, which still have 19 basis points in tightening priced in by year-end, could retrace further even as expectations for the Fed hold firm.

However, positioning hasn't deteriorated significantly in the past week. Three-month option risk reversals—which measure the directional skew in sentiment between bearish and bullish bets—are leaning against the Canadian dollar, but not unusually so. A slow grind toward weaker levels cannot be ruled out, but the more dangerous risk may lie in the other direction: a US-Iran deal that could trigger a sharp repricing in energy markets and rate expectations that could catch an under-hedged market off guard.

*Reaffirming a commitment you technically never abandoned is the diplomatic equivalent of re-gifting.

**This may not be a major hurdle: although the USMCA agreement was structurally almost identical to the NAFTA agreement it replaced, it was presented as a major accomplishment at the time.

***This latest episode does nothing to diminish the ECB's reputation as the Leeroy Jenkins of central banks.

Market Overview

Data as of 7:15 AM EDT

Notes: DXY: Dollar index, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

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