The US/Iran deal has removed one of the most significant tail risks overhanging markets this year. But for bond investors, a seeming end to the conflict is not a green light for duration.
Prior to the deal, markets were pricing an aggressive tightening path across developed market central banks. At the peak, the Federal Reserve (Fed) was priced for close to two hikes this year with further increases expected in 2027, while the European Central Bank (ECB) and Bank of England were both at one point pricing more than three hikes this year. That pricing reflected a scenario of a protracted conflict exhausting strategic reserves, driving oil well above USD90.
With the news of the deal, the probability of that scenario has now been materially reduced. Oil remaining below USD80-90 changes the inflation outlook significantly – what might have been a sustained inflation surge now looks more like a one-off adjustment, which central banks can look through rather than respond to aggressively. Markets have already repriced sharply.
The question is whether this repricing opens the door to a sustained rally. Our view is that it does not – at least not yet. US economic data remains exceptionally strong, driven in part by AI-related capital expenditure, which has partly offset consumer weakness from elevated energy costs. With payrolls robust and no meaningful deterioration in the labour market, the Fed has no immediate reason to cut. For Treasuries to break sustainably below 4%, the market needs to begin pricing a cutting cycle, and that requires labour market weakness that is not yet visible in the data. We think a more likely near-term outcome will be range-bound trading in rates.
For Europe, the economic outlook remains weaker than the US given the region's greater energy import dependence, and the ECB is likely to adopt a more neutral stance as the immediate inflation threat recedes. But a return to the lows seen before 2024 would require a degree of economic weakness that is not our base case.
