The week ahead: Oil prices stabilize as we lead up to the Fed

The focus as we start the new trading week is the escalating tensions between Iran and Israel. There have been strikes from both sides, and there is currently no end in sight, even as world leaders urge for calm. Headline risk is huge as we start a new week. The risk off tone to markets was clear at the end of last week, although the market reaction has been moderate so far on Monday.

For now, it does not look like the markets are pricing in the possibility of a supply side shock for oil. The oil price is higher by a mere 0.5%. and is below $75.00 per barrel, and the gold price is falling. European and US stock market futures are pointing to a higher open later today.

Why are markets so calm?

So, why the sense of calm in financial markets when the war between the two countries continues to rage? President Trump seemed to calm fears when he said that the two sides could find a resolution, but they need to fight it out first. The prospect of US involvement in this conflict used to spook markets, however, now there is a chance that Trump could have a holistic influence. Reports suggest that Trump vetoed an Israeli plan to assassinate Iran’s Supreme Leader, which suggests that he is already having a moderating impact on this conflict, although there has been no direct involvement by US troops.

Due to this, there may need to be a major escalation in the conflict before we get another sharp upswing in oil and gold prices. Financial markets are very good at absorbing geopolitical risk, and Opec+’s supply boost is also helping to cushion the blow.

Back in 2022, when Russia invaded Ukraine, the oil price rose by more than 80% in the weeks and months before Russia invaded Ukraine, however, we may not cross the $100 per barrel level this time. There is expected to be excess oil supply this year and next, which will absorb some of the geopolitical risks for the oil price. Added to this, Opec + Is already boosting their supply, so oil traders will be discounting the supply boost when considering the impact from this latest geopolitical conflict.

Where could Oil go next?

The oil price could have further to run if the conflict takes a more sinister turn. Firstly, if it spreads beyond just Iran and Israel, Secondly, if the attacks against Iran directly target export routes, or if Iran tries to punish Israel or the West by attacking the straits of Hormuz, which is used to transport one fifth of the world’s oil supply.

The key question from a geopolitical standpoint is what does the US do next? President Trump has said that the US could intervene against Iran, and the UK has said that it will send fighter jets to the region. The EU is scheduled to have a meeting about the conflict this Tuesday, and this week’s G7 meeting is likely to be dominated by the situation.

Why Donald Trump could limit Oil’s upside

Interestingly, the US’s involvement could have a calming effect on the oil price. President Trump has proudly touted his ability to keep a lid on oil prices, and we do not think that he will want to entertain a conflict that could put huge pressure on the price of energy. Instead, we think that US involvement could see the attacks on Iran narrow to nuclear sites, after Israel said that it gathered intelligence that Iran had enough uranium to make 9 atomic bombs.

The market reaction

The dollar is giving up last Friday’s gains as we start a new week, suggesting that its role as a haven might be short lived. The dollar was one of the weakest currencies in the G10 FX space last week, however, it did attract some haven flows on Friday, more so than the Swissie and the yen. Bitcoin sold off alongside stocks on Friday, however, it is erasing losses at the start of this week and is back above $106k. We believe that the situation in the Middle East would need to deteriorate rapidly and enter a more dangerous phase for Bitcoin to  fall below $100,000.

Global stocks slumped sharply on Friday; however, the FTSE 100 was protected from the worst of the sell off. The FTSE 100 managed to eke out a gain last week, even though other global indices registered losses. The top performing sector was energy, which benefited from the surge in oil prices. As volatility recedes and if European and US stocks stage a recovery, then we could see UK oil majors and the FTSE 100 underperform at the start of this week.

Can tech lead the stock market recovery?

The weakest stocks on Friday included airlines, credit card companies, and tech, as the prospect of higher interest rates spooked the market. However, with oil stabilizing on Monday, we could see these sectors trying to claw back some gains today. Likewise, bond yields are also receding early in the European session, after rising on Friday. If oil prices can remain contained, then rate cut expectations for the world’s major central banks could remain stable.

In the week ahead, the markets will be incredibly sensitive to headline risk, especially what comes out of the G7 meeting, and the international response to this conflict. However, there are also some key economic events to watch out for. We list the two main ones below.

1, The Federal Reserve meeting

There Is a mere 3% chance of a rate cut from the Fed this week, as the central bank is set to push back against pressure from Donald Trump to cut rates. However, there was some expectation that after a softer inflation print for May, and a clear slowing in the US labour market, the Fed may signal that interest rate cuts would be coming down the line. However, concerns that Chinese tariff rates will remain elevated, along with the recent rise in oil prices could shift the dynamic at the Fed, and we expect them to remain non-committal about the timing of potential future rate cuts.

We also get the latest import price data from the US this week. If they come in stronger than expected on Tuesday, it could lead to a more cautious tone from the Fed when it comes to rate cuts. After recent softer economic data, the market priced in two full hikes from the Fed for the rest of this year. It is imperative that traders look closely at the Fed’s latest Dot Plot of median interest rate expectations, which are also released at this week’s meeting. If the Fed signals only one rate cut is coming this year, then we may see an immediate recalibration of interest rate expectations, further upside pressure on bond yields, especially at the short end of the curve, and the dollar losses may be halted.

2, UK: The May inflation report and the BoE

The Bank of England will announce its latest interest rate decision on Thursday, and they are likely to sound a similar message to the Fed. Upside risks to inflation have increased due to the conflict in the Middle East. The BOE is likely to express the fact that upside inflation pressures are out of its control, and it will remain data dependent when it comes to adjusting policy. This means that if the oil price is elevated in  the long term and this feeds into inflation, the BOE will need to keep a tight lid on rate cuts.

If oil prices remain stable in the coming days, then the market may focus on some expected good news on inflation in the UK. The market expects inflation to soften last month, after April’s jump higher. Weaker price growth is expected to reflect an amendment to vehicle excise duty, and airfares are also expected to have fallen last month, which is why service price growth is expected to moderate to 4.8% from 5.4% in April.

The BOE will also need to maintain a fine balance, since a softening labour market is likely to depress wage growth in the coming quarters. Even so, we expect the BOE to stick with their line that easing monetary policy will be careful and gradual.