News of a peace deal between the U.S. and Iran emerged last week, causing markets to rise. As soon as the news broke on Friday morning, markets flipped on a dime. Oil finished lower on Friday by more than 3%, equities were higher, and the US dollar was lower. Over the weekend, 
more details emerged about the deal including the end of the U.S. naval blockade of the Strait of Hormuz and an end to hostilities, with expectations of a formal signing later this week.1 In pre-open trading this morning equities are rallying, oil is down more than 5%, and the US dollar is down slightly. As we have stated over the past couple of weeks2, it's rather straightforward that markets have been driven by the conflict between the U.S. and Iran since it started and a resolution could help lower the price of oil and, subsequently, the rate of inflation. Last week's release of the May Consumer Price Index showed inflation increased +0.5%, in-line with expectations.3 However, for the second consecutive month, the amount of inflation decreased versus the prior month. The largest component of inflation remains energy, and if you 
were to take out the largest three CPI sub-components in May - Gasoline (+7.0%), Fuel Oil (+3.8%), and Airline Far (+2.7%) - inflation would have increased by only +0.1% instead of +0.5%.3 After Friday's news that a deal might be getting finalized, the rate hike probability for October fell to only 31% and a December rate hike fell to a 58% probability. A signed deal could bring the rate hike odds to near zero and a subsequent drop in oil/inflation could bring a rate cut probability back into play by year-end.4 The reason markets have been shaky lately, other than the continuous stream of conflating headlines, is that the fear of Fed rate hikes and geopolitical shocks are two of the very things that can end a bull market run. Market bubbles tend to burst from any or a combination of the following - Fed rate hikes, liquidity squeeze, external geopolitical shock, regulatory changes/scandal, or valuations peak. As we've already noted, Fed futures are dropping in regard to a potential rate hike. A deal to end the Middle East conflict, which could be signed as early as this week, would reduce geopolitical shocks.1 
In previous posts, we've noted how corporate earnings and revenue justify the rise in equities.2 So, that leaves liquidity or credit squeeze and regulatory changes. There appears to be no current liquidity or credit squeeze as credit spreads remain very low today, unlike previous pre-recessionary periods when spreads moved higher by more than 90% on average over slightly more than 2 months. That leaves a regulatory policy change or scandal as the unknown risk at this point. This could involve AI or an issue related to private equity as a potential culprit. However, we would likely see changes in the other risks as a result, which we are not seeing currently. For now, investors should adjust their expectations and not chase after positions that exceed their stated risk tolerance.
- U.S., Iran notch preliminary peace deal; Trump says Strait of Hormuz to reopen By Investing.com
- War Games
- https://www.bls.gov/news.release/cpi.nr0.htm
- FedWatch - CME Group
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