So, Iran and the US are said to be close to some kind of “interim deal” – which is not a truce or even a deal, but a kind of MOU – an agreement to continue talking. It is not the end. Perhaps it’s the beginning of the end. Perhaps.

At least, that is what financial markets believe; the main reason being that President Trump covets a ramp-off from the war. His domestic opinion numbers are abysmal, as Americans dislike the war itself and even more the effects on prices. His precarious position is clearly visible in what we know so far about a possible deal:

Even though he surely will proclaim a “beauuutiful deal, the greatest ever” it looks like an American defeat. The Strait may open – but it was open before the war started, and now we all know that Iran has the power to close it at will. The agreement on Iran’s nuclear program will probably be no better than Obama’s – which Trump claimed was the worst in history. There will be no regime change in Iran. And America’s influence in the Mid-East will diminish.

Furthermore, we will probably face a somewhat messy period before any deal is sealed and signed. The two partners do not trust each other, and there will be a lot of posturing and grandstanding along the way. Nonetheless, it is very difficult to see Trump restarting the bombings once discussions are underway. So yes: the beginning of the end.

Inflation has been more affected than the real economy
In real terms, the effects of four months of war have not been as detrimental as we feared. So far, oil inventories have covered part of the production losses and economizing on the use of oil products has also helped. Thus, the gap between supply and demand has not yet had calamitous effects. But if the war would continue another month or so, effects will be clearly worse as inventories to a large extend will have been depleted; this is why Trump wants his deal as soon as possible.

The effects on prices have been more visible, with inflation picking up speed; clearly above target, both in the US and the Euro Zone. Even though key rate hikes are not very helpful against supply disturbances, the ECB has already hiked once, to quell any spreading of inflation impulses and expectations. The bank does not want to repeat the mistake from 2022, when it underestimated the inflationary shock and reacted too late. This its key rate is raised now – and more will surely come – to counter rising price expectations among purchasing managers.

In the US, a sharp repricing of Fed’s intentions has taken place, from several anticipated cuts to at least one hike this year. We agree: the new Fed chair cannot start his tenure by proposing rate cuts in the face of high inflation and a hawkish FOMC majority. Longer term, Kevin Warsh will try to refocus Fed’s monetary strategy towards the supply side of the economy (credit growth and productivity) rather than demand. But that will take time and encounter some resistance from more Keynesian-oriented governors at the Fed.

Should the Strait open again during summer, the inflation impulse will not be that long-lasting. Focus will gradually shift away from inflation, and key rates will not have to be hiked strongly. This is our base case: the risks of a sharply higher and longer-lasting inflationary shock have receded.

However, if the “interim deal” collapses, bets are off. Then stagflation will rear its ugly head, with oil prices rising and driving higher inflation for long, while at the same time reducing economic growth.

Bonds stay elevated while stocks go wild
In this uncertain environment bonds have remained elevated, both because of inflation risks and because of high borrowing in major economies. Yields are back to where they were before the financial crisis of 2008-09. The era of free money is over.

Despite these higher yields, several stock markets have been in a frenzy. However, they are also vulnerable. Valuations per se are not stretched in general, but there are doubts that cash flow will suffice to pay for all the huge investments in data centres and energy production. Not surprisingly, some volatility is visible; Bloomberg recently talked about “altitude sickness” as an apt description of the sentiment. The recent huge IPO of SpaceX reflects an almost religious belief in Elon Musk more than a fundamentally motivated re-evaluation of stock markets. Investors are so dazed that traditional valuation models are breaking down.

A peaceful conclusion of the Iran war will support stock markets, but much has already been priced in. Renewed hostilities would mean renewed pessimism, as oil and gas prices would rise sharply.

In this situation, the USD is vulnerable. We see a weakening both for cyclical and structural reasons. Cyclically, if the war winds down, the USD will lose some of the safe-haven status it enjoyed during the war. Structurally, we see termites gnaw at the dollar’s long-term position. Trump’s macro policies are not trustworthy, twin deficits continue to plage the US, and the scheme to make stablecoins a weapon to force foreigners buying more treasuries is far from sufficient. China is slowly but surely pressing trade partners to use the RMB also for international transactions. The dollar’s pre-eminent position in the global financial system is not threatened – yet. But it is being gradually weakened.

Sweden: the glass is half-full
The Swedish economy is doing better than most. The glass is half-full rather than half-empty. Inflation is low, the Riksbank will stay put for now. Exports grow briskly, public consumption as well, and private consumption is helped by pork-barrel tax cuts as we approach the parliamentary election due in September.

As of now, the opposition (left-green) has opened a large lead in the polls. The government (centre-right) has lost its footing, partly because of a few minor scandals, partly because some voters seem uneasy with the increasing strength of the nationalist Sweden Democrats; the party is counting on a strong presence in a future government, with several important cabinet posts.

Should the present landscape remain over election day. SDP leader Magdalena Andersson will return as PM. Our guess is that she does not want to form a government with Left party (partly because their strong affiliation with Palestinians and their demands for sharp tax increases). Rather she will try to find support among Greens and the “middle” parties. If successful, she will form a broad-based government based on compromise towards the middle. There are several possible such outcomes, depending on how the election results will affect the strength of the respective negotiation parties. We expect drawn-out negotiations, and do not exclude that one or two parties in the present government coalition in the end may give passive support to an SDP-led government

In this scenario, the SEK should continue to gradually strengthen, albeit not as much as last year. Strong factors are GDP growth and strong trade performance; negative are a rapidly increasing government debt (albeit from a low level) and a higher ECB key rate. But the positive factors are stronger than the negative, and the general dollar depreciation will mean a stronger SEK vs USD nonetheless.

All in all
Short term, we expect continued financial uncertainty as negotiations over the Gulf proceed. But the risk of serious stagflation shocks has receded, which is a positive factor. The important long-term trend is that bond yields will stay elevated. in this era of geopolitical uncertainty, restructuring of supply chains and rising debts. At the same time, the USD will gradually lose some of its lustre as investors diversify to reduce their dollar dependency.