European stock indexes surrendered some of their recent gains on Tuesday after new US military strikes in southern Iran dampened investor hopes of an imminent peace deal between Washington and Tehran.
Market sentiment had grown more positive over the past week as traders positioned for a de-escalation in the US-Israel war on Iran, which has severely disrupted Middle East oil and gas supplies since it began in late February.
Investors adjusted their outlook on Tuesday after the US confirmed it had carried out what it described as defensive strikes in southern Iran over the preceding day.
US Secretary of State Marco Rubio said on Tuesday that negotiating a deal with Iran could “take a few days”, adding further uncertainty to markets that had been pricing in a near-term resolution.
At 1051 GMT, the STOXX 600 was down 0.2% on the day, though it remained close to its highest level since the conflict began in late February.
London’s FTSE 100 (INDEXFTSE: UKX) bucked the broader European trend, rising 0.7% on the day as it caught up following Monday’s UK bank holiday. Germany’s DAX fell 0.5%, while the MSCI World Equity Index was flat but remained up 3.8% for the month.
Peter Schaffrik, global macro strategist at RBC Capital Markets, said uncertainty in the Middle East was weighing on markets. “It went from agreement is near to everyone needs to sign the Abraham Accords to bombing, so it’s not entirely clear what’s going on there,” he said.
Schaffrik was referring to US President Donald Trump saying on Monday he had told additional countries to sign the Abraham Accords as part of efforts to negotiate an end to the war.
Wall Street futures pointed to gains ahead of the US session, with S&P 500 e-minis up 0.7% and Nasdaq e-minis up 1.1% on the day, suggesting some underlying confidence among investors.
Oil prices climbed sharply, with Brent Crude futures rising 2.4% to $98.50 a barrel. US West Texas Intermediate stood at $92.04, down 4.7% from Friday’s close, with no settlement on Monday due to the Memorial Day holiday.
Schaffrik noted some residual optimism in the market, as traders held on to hope that the Strait of Hormuz could reopen to traffic soon. Brent has fallen considerably from its late April peak above $120 a barrel.
European Central Bank board member Isabel Schnabel told Reuters that the central bank should raise interest rates in June regardless of whether ongoing peace talks with Iran produce a deal.
Schnabel said the conflict had lasted far longer than projected and that high energy prices were spilling into the broader economy, reinforcing the case for tighter monetary policy at the ECB’s next meeting.
Money market traders are pricing in approximately a 90% probability of a rate hike at the ECB’s June meeting, reflecting the weight of Schnabel’s comments and persistent inflationary pressures.
European bond yields rose following the US strikes, though the benchmark 10-year German yield remained close to a near seven-week low at 2.9642%, after declining last week as war-related inflation fears eased slightly.
The US dollar held steady, with the dollar index at 99.026 and the euro flat on the day at $1.1642. The dollar edged 0.1% higher against the Japanese yen, trading at 159.12 yen.
Gold slipped around 0.8% on the day to $4,534.86 per ounce as some investors moved away from safe-haven assets amid the tentative optimism around a potential Hormuz reopening.