Inflation Concerns Ease, Growth Resilient (25-29 May)

Financial markets began the week on a firmer footing as signs of progress in US-Iran negotiations raised the possibility of reopening the Strait of Hormuz and reducing pressure on global energy supplies.

Lower oil prices eased inflation concerns, pushing the dollar lower, supporting the euro and yen, and helping gold and silver recover part of their recent losses. 

Treasury and government bond yields moved lower as expectations for additional central-bank tightening softened, although policymakers continue to signal that further rate increases remain possible if inflation stays above target. Economic data showed resilience in Japan and Germany, while weaker UK figures reinforced expectations that the Bank of England may have less room for additional policy tightening. Key attention now turns to Friday’s US PCE inflation report.

Market Drivers & Catalysts

• Progress in US-Iran Talks: Improving prospects for a diplomatic agreement between Washington and Tehran supported market sentiment. Reports suggesting a potential reopening of the Strait of Hormuz helped ease concerns about energy supply disruptions and regional tensions.
• Oil Market Developments: Crude prices moved lower as hopes for smoother energy flows returned to the market. The decline reduced some inflation pressure and influenced currencies, commodities, and bond yields across major economies.
• Focus on US Inflation: Attention is turning to the upcoming PCE inflation report, the Federal Reserve’s preferred inflation gauge. The data could provide fresh insight into the outlook for US interest rates during the remainder of the year.
• Central Bank Expectations: Recent Federal Reserve communications reinforced the view that additional policy tightening remains possible if inflation proves persistent. At the same time, softer inflation figures in Japan and the UK have reduced pressure for immediate action from their respective central banks.
• Economic Growth Signals: Economic data delivered mixed messages. Japan and Germany reported strong first-quarter GDP growth, highlighting resilience in key economies despite ongoing uncertainty surrounding trade, energy, and global growth.
• UK Economic Performance: A combination of weaker retail sales, softer inflation, slowing labour-market conditions, and contracting business activity has led markets to scale back expectations for further Bank of England rate increases.

Fixed Income

• US 10-Year Treasury Yield: The US 10-year yield fell to 4.56%, reaching its lowest level in a week as lower oil prices eased immediate inflation concerns. Even so, crude remains around 50% above pre-conflict levels. Fed minutes showed policymakers remain willing to tighten further if inflation stays above target, and markets continue to price in a quarter-point increase by year-end. Treasury markets are closed on Monday for the public holiday.
• UK 10-Year Gilt Yield: UK gilt yields moved toward 4.9%, putting them on course for their largest weekly decline since 2024. Weak retail sales, softer inflation, slowing labour-market conditions, and contracting PMIs reduced expectations for further Bank of England action. Developments in US-Iran negotiations also continued to influence sentiment.
• Japan 10-Year Government Bond Yield: Japan’s 10-year yield eased to around 2.71%, retreating from three-decade highs as falling oil prices reduced inflation pressure. Core inflation slowed to a four-year low in April, lowering near-term expectations for policy action. Reports also indicated Prime Minister Takaichi may support additional fiscal measures to offset higher energy costs.
• Germany 10-Year Bund Yield: Germany’s 10-year Bund yield slipped to 2.99%, down 4 basis points on the session. The yield has fallen 5 basis points over the past month but remains 43 basis points above its level a year ago.
• Commodities

Gold advanced toward $4,600 an ounce, recovering part of last week's decline as easing inflation concerns supported precious metals. Reports suggested a potential agreement could reopen the Strait of Hormuz, release frozen Iranian assets, reduce regional tensions, and create a path for future nuclear negotiations. Trump maintained that restrictions would remain until a final agreement is reached. Gold continues to trade roughly 13% below pre-conflict levels.

Silver climbed toward $78 an ounce, recovering alongside gold as optimism surrounding negotiations reduced pressure from inflation and interest-rate expectations. A possible agreement could reopen Hormuz and establish a framework for future talks. Silver remains approximately 17% below levels seen before the conflict. Waller’s policy comments also remained on traders’ radar.

Currencies

• Dollar Index: The dollar index slipped back to the 99 area after touching a six-week high, as signs of progress in US-Iran negotiations and the prospect of reopening the Strait of Hormuz reduced inflation concerns. Trump stressed that any agreement would take time. Expectations of further Fed tightening had supported the dollar last week, but weaker oil prices have since softened that narrative. Focus now turns to the upcoming PCE inflation report, with US markets closed for the holiday.
• Euro: EUR/USD opened the week higher, supported by reduced demand for the dollar as diplomatic developments improved sentiment. The pair returned to the mid-1.1600 range, though traders remain cautious after last week's slide to 1.1575, its lowest level since early April.
• British Pound: Sterling held above $1.34 despite another batch of disappointing UK figures. Retail sales declined 1.3% in April versus expectations for a 0.6% drop, while the budget deficit widened to £24.3 billion, the largest April gap since 2020. Softer inflation, weaker employment indicators, and contracting business activity have lowered expectations for additional Bank of England tightening. Negotiations between Washington and Tehran continue, though disagreements over uranium stockpiles and Hormuz access persist.
• Japanese Yen: The yen strengthened beyond 159 per dollar as lower oil prices and a softer greenback improved demand for the currency. A potential reopening of the Strait of Hormuz would ease energy costs for major Asian importers. Japan’s core inflation slowed to its weakest pace in four years, reducing immediate pressure on the Bank of Japan, although the possibility of future rate increases remains. Market participants also remained alert near the 160 level, where authorities had intervened previously.

Economic Data Highlights

• Japanese GDP (Q1): Japan’s economy grew 0.5% in the first quarter, exceeding expectations of 0.4% and improving from 0.2% growth in the previous quarter, highlighting continued economic resilience.
• UK CPI (April): UK inflation slowed to 2.8% year-on-year in April from 3.3%, below expectations of 3.0% and marking the lowest reading in more than a year. Core inflation eased to 2.5%, services inflation fell to 3.2%, and food inflation slowed to 3.0%. Lower housing and household service costs following the April energy price cap contributed to the decline. Despite softer inflation, expectations for rate cuts remain limited as higher energy costs continue to affect the outlook.
• German GDP (Q1): Germany’s economy expanded 0.3% quarter-on-quarter in the first quarter, exceeding forecasts and improving from 0.2% in the previous quarter. Exports rose 3.3%, driven by chemicals, pharmaceuticals, and metals, while both household and government spending increased. Annual growth reached 0.5%. Most service industries expanded, although construction output fell 4.4%, and employment declined by approximately 157,000 compared with a year earlier.

Macro Calendar Highlights

Monday: Memorial Day (US Holiday).

Friday: US PCE Inflation Report.