Signs of progress in US-Iran talks

Central banks have converged on a similar message over the past two weeks: growth is holding up but the risk of higher inflation hasn’t faded. At the same time, geopolitical risk is easing. Progress in US-Iran negotiations points towards a potential reopening of the Strait of Hormuz, and oil prices have started to fall, which should help ease inflationary pressures. For markets, however, the geopolitical shock is fading faster than the inflation and policy narrative. In fact, equities rose following news of the deal between the US and Iran, before giving back some of those gains. 

In the US, the driver of this shift was clear: policy easing has been pushed back materially. The Federal Reserve (Fed) has revised inflation higher, and quite a few members of the committee now see a rate increase in 2026. Our base case is that there will be one rate hike, taking the policy rate to 3.75-4.0%, while the market is expecting somewhat beyond that. Given this divergence, US Treasury yields have become more attractive, particularly after their rise amid the inflation stress linked to the conflict in the Middle East. This is one reason why we reduced our underweight in Treasuries two weeks ago. Another reason is that we expect lower interest rates next year as growth moderates, the fiscal impulse eases and lower energy prices help reduce inflation. 

Elsewhere, the Bank of Japan raised policy rates to 1%, the highest level since 1995, emphasising that the risk of higher inflation outweighs the risk of slowing economic growth. The European Central Bank (ECB) moved in the same direction the week before, hiking to 2.25%. Both are effectively saying the same thing: while inflation risks are skewed to the upside, the current growth environment remains constructive. 

As somewhat of an outlier, the Bank of England held the Bank rate steady at 3.75%. However, the vote was split across members, suggesting they may still raise rates, even though inflation has eased a bit, risks from the Middle East have fallen, and the jobs market is softer.

Beneath central banks messaging sits the dominant market narrative: AI. Investment in technology is supporting growth across multiple sectors. However, the narrative is shifting from a purely positive outlook to a greater focus on the knock-on effects of this investment. 

Data centre demand is putting pressure on supply in key components, particularly memory chips, and that is feeding into pricing pressure in consumer tech. Apple’s planned price increases tied to input costs are one example. At the same time, the scale of capital spending is rising fast, with firms like Oracle committing heavily to AI infrastructure and facing growing financing needs. 

What this really means is that AI is now pushing both sides of the economic equation. It is supporting growth, but it is also putting upward pressure on prices through supply bottlenecks, costs and regulation, particularly in an environment where interest rates are no longer falling. Earlier expectations, including those from new Fed Chair Kevin Warsh, suggested that AI would primarily act as a disinflationary force through productivity gains. This is yet to be seen.  

Markets still reflect confidence in the AI spending cycle. That is why we remain overweight equities relative to bonds. However, we believe the spending cycle is likely to moderate and the supply, cost and regulatory frictions mentioned above will become more relevant. This is also why we took some profit in equities two weeks ago and reallocated towards US Treasuries. 

This week’s batch of data will test whether the recent US-Iran peace deal and tighter monetary policy narrative is translating into hard economic data or whether it remains largely sentiment-driven. 

Purchasing managers’ indices (Tuesday) across the Eurozone, Germany, France, the UK and the US will be the first read on how firms are adjusting. The key question is simple: are firms seeing a meaningful pick-up in demand or simply feeling less negative about the outlook?  

Consumer and business sentiment may be part of the answer. In Germany, the Ifo business climate (Wednesday) and GfK consumer confidence (Thursday) will shed light on how corporates and households are digesting the ECB’s interest rate increase. In the US, markets will be watching the University of Michigan surveys (Friday), particularly consumer confidence and inflation expectations. 

The main focus, though, will be US inflation with the Fed’s preferred measure, the personal consumption expenditures index (Thursday). After the recent upward revisions to the Fed’s 2026 inflation outlook, investors will be looking for any signs of whether underlying inflationary pressures are building rather than staying confined to energy.  

We’re also keeping an eye on UK politics. Prime Minister Keir Starmer announced that he’ll step down. Starmer’s resignation now paves the way for Greater Manchester mayor Andy Burnham to take control of 10 Downing Street, after he was elected to Parliament following a local by-election win. So far, the absence of a notable market reaction in the UK suggests investors had already anticipated a change in leadership. Looking ahead, market focus is likely to remain on fiscal credibility rather than personalities, with the experience of the 2022 mini budget crisis still in mind. 

While Burnham is often perceived as being from Labour’s more interventionist wing, investors have so far taken comfort from indications that any future administration would broadly maintain fiscal discipline. Much will depend on the economic team that emerges, particularly the choice of Chancellor and whether existing fiscal rules remain intact. In a nutshell, markets currently appear to view a potential Starmer-to-Burnham transition as a political event rather than a fiscal one. A change of this outlook is where risk lie.