While the news isn’t entirely surprising—there had been reports of Israel preparing action and the U.S. ordered Americans to leave the region earlier this week—the Israeli strikes could mark the beginning of wider regional tensions. If Israel continues operations beyond its borders, the Middle East could heat up fast.

Latest: Israel says Iran’s nuclear program poses an existential threat and vows that its operation will continue for as long as necessary. Iran has already launched hundreds of drones in retaliation and could go further. But how much further?

Back in October 2024, Israel had launched a major strike on Iranian nuclear facilities. At the time, Iran responded with drone attacks that were mostly intercepted and perceived more as a warning than a retaliation. Tensions eventually eased and markets quickly settled. A similar de-escalation is possible now—but not guaranteed. Judging by the price action, the market’s response to last night’s attack has been very strong.

The price of US crude jumped as much as 13%, trading past $77 per barrel in the early hours of today, while Brent also surged past $76pb. Prices have since pulled back slightly, but tensions are far from over.

One scenario is de-escalation, which could bring oil back below $70 per barrel, around the 200-day moving average, shifting the market's attention back to supply-demand dynamics, trade disruptions, and renewed pressure on Russian oil.
The other scenario is broader escalation, potentially pushing oil prices toward $90–$100 per barrel—hopefully only temporarily.

Beyond oil, if tensions disrupt transit through the Strait of Hormuz, LNG flows could also be hit—as roughly one-fifth of global LNG passes through the strait. So far, there's no major price action on that front. Let’s hope tensions ease before broader disruptions emerge.

US and Iran are expected to meet in Oman this Sunday to discuss Iran’s nuclear program—so this weekend could bring fresh developments.

Naturally, rising geopolitical tensions are powering haven assets. Gold is up 1%, trading just below its all-time high, while the USDCHF is flirting with the 0.80 support level despite broad US dollar strength.

Yet, that US dollar rebound follows a sharp drop—recent lows not seen since April 2022—on the back of another round of soft inflation data released yesterday. US producer prices rose less than expected in May, easing concerns that inflation would spike in response to tariffs.

The US 2-year yield slipped below 3.90% on rising expectations of a dovish Federal Reserve (Fed), though Fed funds futures still price less than a 30% chance of a July rate cut. On the long end, the 10-year is seeing haven flows on Mid-East tensions, and the 30-year also found demand—particularly after yesterday’s $22bn auction attracted strong interest, suggesting that markets have absorbed latest US debt worries. America can keep spending—markets will finance it. What a wonderful world.

In equities: soft inflation and falling yields supported US equities yesterday, but futures are sharply lower this morning. Oil and defense stocks will likely benefit from rising tensions, but the rest of the market should remain under pressure.

Looking beyond geopolitics and risk-off mood, US equity valuations look stretched, especially compared to bond yields. The equity risk premium—the difference between equity and Treasury returns—has fallen to its lowest since 2002 for the S&P500, and is now negative. That means investors currently get better returns from US Treasuries than from the S&P 500, which yields around 3.60%.

That relatively low return is partly due to the relentless rally in Big Tech and partly due to yields hitting multi-decade highs. Excluding the Magnificent 7, the rest of the S&P 493 yields about 5%—but even then, they offer only a minor risk premium over Treasuries, which are supposed to be ‘low risk.’ How low that risk really is, of course, is debatable. But history shows the US has always managed to make markets digest its debt.

Anyhow, many investors may prefer to take risk off the table ahead of what could be a volatile weekend in terms of geopolitical headlines.