Ahead Today
G3: US PCE Price Index, US Initial Jobless Claims
Asia: Malaysia industrial production
Market Highlights
The two-week ceasefire is barely a day old, and it seems there are already cracks forming, even as financial markets remained relatively buoyant with a weaker Dollar and stronger Asian currencies holding up as well so far. In particular, Iran threatened to withdraw from the ceasefire arrangement after Israel launched strikes across Lebanon, with a senior commander of Iran’s Islamic Revolutionary Guard Corps saying the country was “preparing to respond” to Israeli attacks in Lebanon. Meanwhile, Mahammad Bagher Ghalibaf, one of Iran’s top civilian leaders, said the basis under which talks were supposed to take place had been violated even before negotiations began, and these include an immediate ceasefire everywhere including Lebanon, entry of a drone into Iran’s airspace, and denial of Iran’s right to enrichment, which was included in Iran’s sixth clause of the framework. There were also signs of attacks by Iran on Saudi Arabia’s East West pipelines and other infrastructure in the Middle East even amidst all these.
From our perspective, while financial markets are buoyant, what will matter ultimately is the physical market and whether the barrels will ultimately flow. On that front, although the traffic has improved in terms of number of ships leaving the Strait of Hormuz in part with tolls from Iran, the Oman route and diplomatic negotiations, the overall level of traffic remains far too low and still focused on ships/tankers leaving rather than ships/tankers entering the SoH right now.
Overall, we continue to think that given the big gaps in expectation between different parties and not just the US, the chance of a durable ceasefire and agreement remains very narrow, and as such the risk of a flare up and continued volatility is very substantial. What’s most telling for the path ahead is perhaps the Financial Times article that it was the US who was pushing extremely hard for this deal with Iran through Pakistan, with Trump eager for a ceasefire since at least his first threat on 21 March given he is worried about surging oil prices and surprised by a resilient Iranian regime. Overall, we think this shows that Iran will likely remain firm on its demands including negotiating on the basis of its 10-point plan given its perception of having an upper hand, and as such also for the other key actors in this conflict including Israel and the Gulf states to remain divergent in their perceptions of where the ultimate landing point will be acceptable for them.
As such, we continue to advise taking a cautious stance on risk despite the current buoyancy in financial markets, and for our clients if possible to take opportunities to hedge some of positions at current better levels especially against more vulnerable Emerging Market currencies in our region such as INR, PHP, THB and KRW.
In Asia, the Reserve Bank of India kept its policy rate on hold while keeping a neutral stance in what was a unanimous vote, as it signalled a focus on keeping rupee stability over supporting growth. Governor Malhotra highlighted upside risks to inflation and downside risks to growth from the Iran conflict and global oil prices, even as he signalled overall confidence in the Indian economy and macro buffers in withstanding these external shocks. The RBI is projecting some modest slowdown in growth with GDP at 6.9% and inflation at 4.6% for FY2026/27, with an assumption of crude oil at US$85/bbl average.
On the recent RBI FX measures, Governor Malhotra described RBI’s FX measures as temporary, reaffirmed commitment to support Rupee internationalization over the medium-term, while framed the measures as a way to weed out short-term speculation and pressure that had been building up on one-way INR depreciation bets.
We are somewhat less sanguine than RBI on this, and we do fear that there will be unintended long-term side effects from these FX measures however, including questions around policy certainty and how that will ultimately spillover into capital inflows into India both in the short and medium-term.
In our base-case we think USD/INR can trade between the 94.00 to 95.00 range over time. In a risk case of oil prices resuming its rise, we think USD/INR may trade closer to the 97.00 to 98.00 range. While we see RBI keeping rates on hold for now, the meaningful risk of second round effects on food prices, potential fiscal slippages and weakness in capital inflows should result in a bias for overall INR interest rate yield structure to remain sticky moving forward.