World Eyes Iran's Presedential Election

Welcome back to SovereignBeat!

In this publication:

• PCE data boosts Fed confidence for rate cuts

• Yen hits 38-year low; BoJ likely to intervene

• Equities keep floating near record highs

• Oil demand hits highest level since December

• Iran faces choice between ultraconservative and reformist president

Let’s dissect

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Markets Snapshot

Developed Markets

• US: In May, the Federal Reserve's preferred measure for assessing underlying US inflation showed signs of slowing, supporting the argument for potential interest rate reductions later this year. According to the Bureau of Economic Analysis, the core personal consumption expenditures (PCE) price index, which excludes the volatile food and energy sectors, rose by 2.6% annually and just 0.08% from the previous month, the smallest increase in six months. The overall PCE index remained flat on a monthly basis.

• Simultaneously, inflation-adjusted household spending increased by 0.3% following a decline in April. The growth in consumer spending was primarily driven by goods and partially attributed to rising incomes, with inflation-adjusted real disposable income jumping 0.5%—the most since January 2023—after a flat reading in April. The combination of slower price increases and strong spending provides some relief to Fed officials, suggesting that inflation can be controlled without causing lasting harm to consumers. This is especially significant after several reports earlier this week indicated a slowdown in economic momentum. Following the data release, short-term Treasury yields initially dropped due to anticipated rate cuts but quickly rebounded, with the 2-year Treasury yield reaching 4.75% by the end of trading on Friday. The implied probability of at least one rate cut in September currently stands at 63%, down 2% from last week.

• Japan: The value of Japan’s currency relative to the U.S. dollar fell on Friday to 160.82, its lowest level since 1986. The dollar has gained about 14% versus the yen this year. The euro also surged against the yen, rising to 171.79, its highest since September 1992. The yen has been steadily depreciating since the Bank of Japan (BoJ) ended its negative interest rate policy and scrapped its yield curve control policy in March 2024.

• The core consumer price index (CPI) in Tokyo, a leading indicator of nationwide inflation figures, rose by 2.1% in June compared to the previous year, up from May's 1.9% increase and surpassing market expectations of a 2.0% rise. This growth was primarily driven by services inflation and has sparked speculation that the BoJ will either taper its extensive bond-buying program at its July meeting to improve market functioning, hike interest rates, or do both. The yield on the 10-year Japanese government bond rose to 1.05% from 0.98% a week ago, driven by growing anticipation of further monetary policy tightening by the BoJ.

• Nonetheless, Japan’s stock markets rose over the week, with the Nikkei 225 Index gaining 2.6% and the broader TOPIX Index up 3.1%, as the historic weakness in the yen continued to support the country’s export-heavy industries.

Equity Markets

• The S&P 500 remained flat week on week, while the NASDAQ rose slightly, with both indexes remaining near record highs in a quiet week of trading. The Dow slipped this week, staying about 2% below the record set six weeks earlier.

• On a monthly basis, the NASDAQ led the way with a nearly 6.0% increase in June, whereas the Dow saw a more modest rise of 1.1%. The S&P 500 gained 3.5%, achieving its seventh positive month in the last eight.

Commodity Markets

• Oil: Oil prices recorded gains for the third straight week amid geopolitical tensions, with the Brent spot price ending the week at $84.84. Brent crude futures for August delivery stabilized at $86.41 a barrel, achieving weekly, monthly, quarterly, and semi-annual gains of 1.35%, 6.55%, 1.25%, and 13.45%, respectively. U.S. crude oil production rose by 72,000 barrels per day (bpd) month-on-month to 13.25 million bpd in April, while oil demand increased to 20 million bpd, the highest level since December 2023, according to Energy Information Administration data.

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Geopolitics

Iran Votes on a New President

• The presidential snap election in Iran was held on June 28, triggered by President Ebrahim Raisi's death in a helicopter crash last month. None of the four candidates secured more than 50% of the vote on Friday , prompting a second round on July 5. Out of 60 million eligible voters, 24 million cast their ballots, resulting in a 40% turnout, marking a record low in the Islamic Republic where many have lost faith in the process. Reformist contender Masoud Pezeshkian led the polls with 42.4 percent of the vote, followed by ultraconservative Saeed Jalili with 38.6 percent, while both will face each other in a runoff election.

• Masoud Pezeshkian is a heart surgeon and former health minister who has advocated for reviving the 2015 deal between Iran and world powers (the U.S., China, Russia, the U.K., France and Germany) to limit Iran's nuclear program in exchange for lifting Western economic sanctions. The deal broke down after the US, under then-President Donald Trump, withdrew from it and reinstated sanctions in 2018. Pezeshkian believes that the lack of foreign direct investment (FDI) and the banking sector's non-compliance with Financial Action Task Force (FATF) standards are holding the country back. Conversely, his main opponent, Saeed Jalili, views the penalties and sanctions as a badge of honor and seeks closer ties with China and Russia, even including supporting the Kremlin’s war in Ukraine. Jalili opposes complying with FATF standards, as it could hinder Iran's support for groups like Hamas and Hezbollah.

• In Iran, the Guardian Council, a 12-member body, decides election candidates. Half its members are appointed by the supreme leader, while the other half are chosen by parliament. There’s a widespread belief, however, the council's decisions reflect Supreme Leader Khamenei's preferences on who should be permitted to run. The Guardian Council has a track record of disqualifying popular or well-known politicians and very senior clerics, often with little or no explanation, undermining the credibility and fairness of the process. Women can apply as candidates, and many have, but none have ever received final approval from the Guardian Council, confirming the common belief that they are effectively excluded.

Our thoughts:

• The Islamic Republic has been isolated from global financial markets for years and still desperately needs to increase FDI, which remains tiny in comparison to regional peers. Regardless of who wins, the ultimate power will still remain with Supreme Leader Ayatollah Ali Khamenei, who has the final say on foreign and military policy. Hence, we don’t expect any major changes in the country's relationships with the West, China, and Russia. However, the president can still wield influence through popular support, political affiliations, and connections to powerful institutions.

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