The implementation of a phased US-Iran agreement has led to a significant drop in oil prices, yet the tepid rebound in risk assets has left many market participants disappointed.
According to analysis, Deutsche Bank AG macro strategist Henry Allen noted in a recent report that a combination of four pressures—a hawkish pivot by the Federal Reserve, pre-emptive market pricing of positive news, excessive valuations, and the lack of substantive restoration of transit through the Strait of Hormuz—collectively suppressed what should have been a much stronger relief rally.
The Federal Reserve's Hawkish Turn and Surging Real Rates Offset Geopolitical Tailwinds
The Fed's policy decision last Wednesday became the most immediate "countervailing force." The dot plot revealed that half of the officials forecast at least one rate hike this year, with the new Chair Warsh explicitly emphasizing the priority of restoring price stability. This hawkish signal pushed the US 10-year real yield to close at 2.22% on the decision day, a more than one-year high. The sudden spike in real interest rates directly offset the improvement in risk appetite brought by the agreement.
Favorable Expectations Were Already Priced In, Limiting Upside from the Deal
The market's muted reaction had been telegraphed—since the Iran conflict erupted, investors have consistently characterized it as a "temporary conflict," with the oil futures curve persistently reflecting expectations for a price decline in the coming months.
This meant the potential additional upside from the deal's conclusion was severely constrained from the outset. Currently, the deep backwardation in the Brent crude futures curve has largely dissipated, with the curve's shape nearly reverting to February levels. In other words, the market had already priced in the expectation that "the conflict would eventually be resolved," making the actual deal's confirmation a realization of existing expectations rather than a new positive shock.
Excessive Valuations Have Compressed Further Upside Potential
Between April and May, risk assets experienced a historic rally. The S&P 500 index surged 16% over two months, a magnitude of two-month gain that has occurred only four times since WWII. Three of those instances happened during post-recession rebounds, with the sole exception occurring in the months preceding the 1987 "Black Monday" crash.
This rally was not confined to equities. By early June, US and European high-yield credit spreads had retreated to levels seen before the Iran conflict erupted, despite the Strait of Hormuz remaining blocked and oil prices staying elevated. This month, the S&P 500's cyclically adjusted price-to-earnings (CAPE) ratio climbed to its highest level since 2000, just before the dot-com bubble burst. Such extreme overvaluation left the market with almost no room for further upside following the deal's announcement.
No Substantive Restoration of Strait of Hormuz Transit, Supply Concerns Linger
Although oil prices have retreated from their highs, the structural supply issue concerning the Strait of Hormuz has not been fundamentally resolved. According to the Deutsche Bank AG report, the current number of oil tanker transits through the strait remains only a fraction of pre-conflict levels, with Brent crude prices still about 30% higher than at the start of the year.
Given that approximately 20% to 25% of global oil supply transited the Strait of Hormuz before the conflict, whether transit can be substantively restored will be the core variable most watched by markets in subsequent negotiation phases. Until this issue is clearly resolved, the downside potential for oil prices and their effect on improving inflation expectations will remain constrained.
Under Multiple Pressures, Medium- to Long-Term Prospects Still Have Support
Deutsche Bank AG believes that while the aforementioned four pressures have suppressed the recent rebound, there are still reasons for cautious optimism in the medium to long term.
First, behind the Fed's hawkish stance lies a persistently strong labor market—the last three non-farm payroll reports have all exceeded expectations. This is fundamentally different from the bear market pattern during the 2022 hiking cycle, which was accompanied by continuously downgraded growth expectations. If the Fed's motivation for tightening stems from upside growth surprises, historical experience suggests risk assets can still withstand it, with early 2024 serving as a typical case.
Second, although the current rally is being compared to the period before the 1987 Black Monday, there are key differences: the S&P 500's year-to-date gain is about 10%, far below the 39% gain before the 1987 crash. Furthermore, current circuit breaker rules mandate a market halt if the index falls more than 20% in a single day, mechanically precluding the possibility of an extreme single-day crash.
Finally, the underlying logic of macroeconomic resilience remains unchanged. Data continues to surprise to the upside, with no signs yet of the substantive macro deterioration historically required to trigger large-scale sell-offs, whether in energy shock scenarios or broader economic downturns.
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