Significant Progress in US-Iran Talks: Why Is the Market's Reaction Tepid?

The phased agreement between the US and Iran has been implemented, oil prices have sharply retreated, but the rebound in risk assets has disappointed market participants.

According to Chase Trading Desk, Henry Allen, a macro strategist at Deutsche Bank, pointed out in his latest research report that the Fed’s hawkish shift, markets having already priced in the positives, excessive valuation, and the fact that passage through the Strait of Hormuz has not been substantially restored—these four pressures combined have suppressed what should have been a stronger relief rally.

The Fed’s policy decision last Wednesday became the most immediate “hedging force”. The dot plot shows half of the officials expect at least one rate hike this year, and the new Chair Warsh explicitly emphasized the priority of restoring price stability. This hawkish signal pushed the US 10-year real yield to close at 2.22% on the day of the decision, a new high in over a year. The sharp rise in real rates directly offset the improvement in risk appetite brought by the agreement.

Meanwhile, the S&P 500 index is still below this month’s historical high, credit spreads have widened during this period, and several financial stress indicators have also risen. This pattern indicates that the market impact from the agreement falls far short of some investors’ expectations.

The Fed’s Hawkish Turn: Surge in Real Rates Offset Geopolitical Positives

The Fed’s decision last week sent multiple hawkish signals that caught the market off guard. The dot plot shows half of the participating officials expect at least one rate hike this year, and Warsh emphasized the price stability target in his speech. This shift is not an isolated event; behind it lies a macro backdrop of global economic data consistently beating expectations—since the outbreak of the Iran conflict, global data resilience has continually exceeded market forecasts.

The rapid rise in real rates is the most direct transmission pathway to the market. After the Fed’s decision, the US 10-year real yield closed at 2.22%, the highest in more than a year; Germany’s 10-year real yield also rose to 0.89% last Friday, a five-month high. Rising real rates mean higher funding costs and suppressed risk asset valuations, which largely offset the declining geopolitical risk premium brought by the US-Iran agreement.

Expectations Priced In Early: Limited Upside for Agreement Implementation

The market’s weak rebound was foreshadowed—since the Iran conflict erupted, investors have consistently viewed it as a “temporary conflict,” and oil price futures curves have continually reflected the expectation that oil prices would drop in the coming months.

This means the extra upside the agreement could deliver was severely compressed from the start. Currently, the deep spot premium (backwardation) structure of Brent crude futures has basically dissipated, and the curve shape is nearly back to February levels. In other words, the market had already priced in the expectation that “the conflict will eventually be resolved,” so the actual agreement merely confirmed existing expectations rather than delivering a new positive shock.

Severe Overvaluation: Historical Rallies Compress Further Upside

From April to May, risk assets experienced a round of historic rebound. The S&P 500 index rose 16% in two months; such a two-month increase has only happened four times since WWII, three of which were rebounds after recessions, and the only case outside a recession occurred months before the “Black Monday” crash in 1987.

This rally was not limited to stocks. By early June, US and European high-yield credit spreads had fallen back to pre-Iran conflict levels, even though the Strait of Hormuz was still blocked and oil prices remained high at that time. This month, the S&P 500’s cyclically adjusted price-to-earnings ratio (CAPE) has climbed to its highest since 2000—right before the dot-com bubble burst. Excessive valuation leaves almost no room for further market upside after the agreement takes effect.

Strait of Hormuz Passage Not Substantially Restored: Supply Concerns Remain

Although oil prices have retreated from highs, the structural supply issues of the Strait of Hormuz have not been fundamentally resolved. According to Deutsche Bank, the number of tankers passing through the strait is still only a fraction of pre-conflict levels, and Brent oil prices remain about 30% above the start of the year.

Considering that before the conflict, about 20% to 25% of global oil supply was transported through the Strait of Hormuz, whether passage can be substantially restored is the key variable the market will focus on in subsequent negotiations. Before this question is clearly answered, the downside for oil prices and improvement in inflation expectations will remain limited.

Under Multiple Pressures, Medium-Long Term Outlook Still Supported

Deutsche Bank believes that although the above four pressures have suppressed the recent rebound, there are still reasons to remain cautiously optimistic in the medium to long term.

First, behind the Fed’s hawkish stance is a consistently strong job market—the latest three nonfarm payroll reports have all exceeded expectations, which is fundamentally different from the bear market pattern seen in the 2022 rate hike cycle when growth expectations were continually downgraded. If the Fed’s tightening is driven by positive growth surprises, historical experience suggests risk assets can still bear the pressure—2024’s start is a typical case.

Second, although the market compares this rally to the run-up before the 1987 Black Monday crash, there are key differences: the S&P 500’s gain so far this year is about 10%, far below the 39% gain before the 1987 crash; furthermore, current circuit-breaker rules stipulate that a single-day decline of over 20% triggers a suspension, eliminating the possibility of an extreme crash in one day from a systemic standpoint.

Finally, the underlying logic of macroeconomic resilience has not changed. Data continues to beat expectations, and so far there are no signs of the kind of macro deterioration that historically triggers large-scale sell-offs, whether in energy shock scenarios or broader economic downturns.

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