Central Bank De-Dollarization and the Israel-Iran Conflict: Impact on Global Markets

On Tuesday, the fifth day of the Israel-Iran conflict pushed oil prices higher and world stock markets lower, as investors also digested weaker-than-expected U.S. economic data and awaited the Federal Reserve's policy decision on Wednesday. The escalation of the conflict further unnerved investors, with stocks falling across the board, oil prices surging, and government bond yields falling sharply.

Key Market Moves:

• Stocks ended in the red, with main U.S. and European indices falling 0.7%-1.1%, while Asia held up better - China was flat, Japan in the green, and MSCI Asia ex-Japan down 0.4%.
• The dollar had its best day in over a month, rising 0.8% and rebounding from last week's three-and-a-half-year low.
• Oil leaped more than 4%, with Brent futures well above $76/bbl and WTI futures back above $75/bbl.
• Treasury yields fell across the curve, with the long end falling as much as 7 bps as the curve flattened. A $23 billion auction of 5-year TIPS drew strong demand.
• Silver rose above $37/oz for the first time in over 13 years, up 12% so far this month, pulling away from gold, which is up 2% in June.

The U.S. retail sales and industrial production figures were weaker than expected, suggesting that U.S. consumers are drawing in their horns and factories are feeling the squeeze even before tariffs hit. This could slow growth in the second half of the year.

The outlook for tariffs, growth, and inflation - not to mention war in the Middle East - will guide the Fed's policy decision and revised economic projections on Wednesday. It's an increasingly difficult line for Chair Jerome Powell and his colleagues to tread.

Meanwhile, the Bank of Japan adopted a more cautious stance on Tuesday, leaving its short-term policy rate on hold at 0.5%, as expected, and voting to slow the pace of balance sheet rundown in fiscal year 2026. With the BOJ's policy rate likely to remain on hold for the rest of the year and the pace of balance sheet reduction not changing until March, the impact on Japanese assets in the near term could be limited.

However, investors will not be getting complacent - the Israel-Iran war and Fed decision on Wednesday will continue to dominate market sentiment. Foreign central banks are shrinking their U.S. asset exposure, with the value of U.S. Treasuries held at their lowest since 2017, indicating a trend towards de-dollarization.