US-Iran MOU signed electronically, paving the way for the Strait of Hormuz to gradually reopen. Brent crude falls to US$83/bbl; solid gains in many equity markets. Muted reaction for bonds and currencies

Oil prices fell and global equities rebounded following confirmation of a US-Iran agreement that will extend the ceasefire and allow the Strait of Hormuz to reopen for shipping. Bonds and currencies show more limited movement. Indeed, the US 10-year rate has increased since the NZ close while the NZD has reversed all of yesterday’s gain to trade flat relative to the weekend close of 0.5830.

The new week began with Pakistan’s Prime Minister announcing that a US-Iran peace deal had been reached. This was soon confirmed by President Trump, who said the deal was now complete and he authorised the “toll free” reopening of the Strait of Hormuz, along with the “simultaneous” immediate removal of the US naval blockade. All of this was said to take effect from Friday, upon signing of the deal.

While the broad contours of the deal are known, the details have yet to be revealed. Suffice it to say, the easy part has been done – negotiating the reopening of the Strait of Hormuz, which will slowly allow oil to flow freely again – while the hard part, namely nuclear negotiations, has been kicked down the road.

In overnight news, it has been revealed that an electronic version of the so-called Memorandum of Understanding has already been signed by Trump, Vance and Iranian Parliament speaker Ghalibaf. Text of the MoU will be revealed within 24-48 hours of its official signing in Switzerland on Friday. Israel is not in favour of the agreement, and its defence minister said the military would hold its security zone on Lebanon indefinitely.

Once signed, the MoU extends the US-Iran ceasefire by 60 days and kicks off negotiations about restricting Iran’s enrichment of uranium for about 15 years.  The truce can be extended further if need be. Iran media reported Iran and Oman will regulate ships passing through the Strait of Hormuz. They will allow transit of vessels free of charge for only 60 days and plan to charge for safety, navigation, environmental and insurance services after that period. That point will be up to negotiation as part of further discussions.

Thus, already the MoU remains on shaky ground. Many are sceptical that any nuclear agreement can be made within 60-days. It wouldn’t surprise if negotiations drag on into next year.  However, for markets and the global economy, the key point is that tail risk around oil shortages and severe negative impacts has been significantly reduced.

Brent crude is currently trading at USD83 per barrel, down nearly 5% from last week’s close and with no further fall overnight. With the Strait of Hormuz needing to be de-mined and insurers needing more certainty of safety before diving back in, it is well acknowledged that it will take a long time for oil markets to return to normal, while replenishing inventories will add some ongoing solid support to demand. This will limit the scope for oil prices to fall much further over the short-term.

Global equities have increased, with outperformance in some Asian markets which have been more impacted than others from the conflict. Japan’s Nikkei closed up 5% to a fresh record high. European equities have shown more modest gains and UK’s FTSE 100 fell 0.4%, meaning UK stocks were a drag on the Euro Stoxx 600, which closed up just 0.2%.  A strong rebound in the IT sector propelled the US S&P500 up 1.7% by late afternoon trading, with the Nasdaq index up 3%.

US Treasuries were strong on the Asian open, seeing the 10-year fall to a low of 4.42%.  Since then, the rates have grinded higher and the 10-year rate sits at 4.47%, down just 1bp from the weekend close and up 4bps from yesterday’s NZ close.

Second-tier US economic data didn’t impact the market but were softer than expected.  The Empire State manufacturing index, the first of the Fed’s regional manufacturing surveys for June, dropped to 5.7 from 19.6, industrial production rose by only 0.1% m/m in May, although net revisions were positive, while the NAHB housing market index of homebuilder sentiment edged down to 35.

Currency market reaction has been well contained.  The AUD has outperformed, albeit with only a modest gain to 0.7075. The NZD hasn’t sustained the initial positive reaction, which saw it trade to a high of 0.5864 in early trading, and overnight it has fallen back down to 0.5830, leaving it little changed from last week’s close.  NZD/AUD has fallen to 0.8235.  The NZD is slightly weaker on EUR and GBP crosses.

Global forces sent NZ rates lower yesterday, with a little bit of local market outperformance added to the mix, sending NZ-global rates spreads even lower.  NZGB yields fell 6-8bps across the curve, with a modest steepening bias. This left the 10-year rate at 4.41%, just below the US 10-year rate at the time, adding to the significant NZ-US rate compression seen over the past couple of months.  Swap rates showed a similar move, down 5-7bps, taking the 2-year rate to 3.33%, its lowest close in three months.

NZ economic data were mixed, with another disappointing fall in the performance of services index while electronic card transactions rebounded strongly in May, after the significant fall in April.

In the day ahead, NZ’s monthly CPI indicators for May will feed into views on how high inflation reached in Q2. China’s monthly activity indicators, along with RBA and BoJ policy updates, are scheduled for this afternoon. The market is pricing next to no chance of a fourth consecutive rate hike by the RBA at this meeting, although the central bank is unlikely to abandon its tightening bias so soon. The BoJ is widely expected to hike by 25bps to 1.0%, which would be its first increase since December, and this outcome is already well priced by the market. The Bank will need to guide towards further tightening otherwise the yen will be vulnerable to downside pressure. Only second-tier US housing data are due for release tonight.

Jason Wong is the senior Markets Strategist at BNZ Markets.