To get John Authers’ newsletter delivered directly to your inbox, sign up here.

Today’s Points:

• Another geopolitical risk bites the dust: The Iran-Israel truce is holding.
• The Make America Exceptional Again trade is trying to take off.
• NATO members have agreed to spend 5% of GDP on defense.
• Get ready for the next wave of US banking M&A.
• AND: More hot hot hot music for the heat wave.

Glad It’s All Over

Glad it’s all over? The conflagration in the Middle East, like all those that went before it, mattered chiefly to global markets if it threatened the supply of oil. Iran could, if it wanted, stop tankers from going through the Strait of Hormuz for a while. The perception that it might do so (at great cost to itself) reared after the US attacked Iranian nuclear facilities, and then dwindled when Iran’s limited response against a regional US air base showed that it wouldn’t go that far. This is how odds moved on the Polymarket prediction market:

There’s room for argument about exactly how much damage the US has done to the Iranian nuclear project, but what matters for markets is that Tehran’s behavior makes clear that they aren’t going to close the Strait. As it’s hard to imagine a more obvious  time, it lowers the odds they’d do so in the future. Hence, the oil supply is safe; this is what matters most to markets.

Nobody thinks the long-running conflict has been resolved. Dangers very much remain. But the nuclear program is one of many geopolitical risks that have grumbled on in the background for years without affecting market valuations. Until the situation flares up again, the market can get back to ignoring Iran and its centrifuges.

The Israel-Iran ceasefire is a big political achievement for President Donald Trump. A more significant win, in economic terms, is his success in getting NATO allies to raise their defense spending. Not many would have seen that coming even a few months ago. There’s ample room to question the negotiating tactics he used, but they were effective.

International markets are handing Trump 2.0 another victory. The S&P 500 is almost back to its record. Treasury Secretary Scott Bessent has targeted lower bond yields, cheaper oil, and a weaker dollar. The market is delivering all of them:

Trump successes have led to a new idea. “Client questions recently reinforce our impression of a building narrative,” says Freya Beamish of TS Lombard. “Is the TACO [Trump Always Chickens Out] trade morphing into a reawakening of the US exceptionalism trade?”

It’s questionable, however, whether American Exceptionalism — the relentless outperformance by US stocks — will resume after taking a break for the last few months. The most recent developments don’t help US outperformance. Cheaper oil is more important for European and Asia-Pacific economies than for the US, while the benefits of NATO members spending more on defense will likely flow primarily to European companies.

And while the market trend has shown the US regaining ground, there’s no sign that investors are rethinking the judgment they made earlier this year that tariffs were a good reason to move elsewhere. In relative terms, the US has gained nothing since the eve of Liberation Day, April 2:

Recent fund flows have helped Europe; this could continue. Societe Generale SA demonstrates that inflows to European funds actually exceeded those to the US over the last three months, while money has also gone into global funds that exclude the US. There are no flows out of the US as yet, so no particular reason to think that this trend cannot intensify. And in any case, as other markets are smaller, any investment into them will have greater proportionate impact: 

What hasn’t changed, at all, since Liberation Day and its subsequent reverses is the severing of the link between the dollar and its rate differentials. Normally, a currency will be aided by higher bond yields than are available elsewhere, as this will attract flows. That hasn’t happened this time. As this chart from Adarsh Sinha of Bank of America demonstrates, the relationship continues to weaken:

The correlation could be restored if the Federal Reserve were to go through with cutting rates a little earlier than expected, and thus reduce rate differentials. “Earlier rate cuts by the Fed, whether accompanied by weaker data or not, would imply downside risk to our broader USD forecasts,” says Sinha. 

The context of cuts would matter. If the US labor market finally begins to crack, that would force the Fed to act and would weaken the dollar. Tariffs and the possibility that they raise inflation are causing the Fed to stay its hand for now — and again, if  inflation does recur, that isn’t going to help the dollar. 

Further, the administration wants a weaker dollar. Washington is getting its way on military spending, and can probably get its way on this, too. If it were to pressure the Fed into cutting rates prematurely, that would weaken the dollar not only by lowering rate differentials, but also by harming the credibility of the central bank. 

Beamish suggests that the odds are stacked against the US, because “the probability that either the labor market cracks and/or the tariff effects show up in inflation” seems greater than “the probability that inflation continues to slow and the labor market holds up.” It’s best to assume that US exceptionalism will have to stay in abeyance a while longer. 

Rebound or False Hope?

US mergers and acquisitions activity has failed to live up to expectations in the first half of this year. There are obvious reasons, headed by extreme economic policy uncertainty. But for the second half, the hope is for a slew of trade deals, monetary policy easing, and favorable regulations. That has reignited hopes for an M&A rebound. 

FactSet’s M&A activity tracker found that while deal activity in May slowed by 7.9% compared to April, aggregate spending was up by over 40%. Fifteen out of the 21 sectors tracked experienced a decrease in M&A deal activity over the past three months compared to the same period a year ago. The good thing about such broad underperformance is that it lowers the bar for recovery. This is how Citigroup Inc.’s basket of stocks considered to be acquisition targets has performed over the last year:

The underlying assumption is that the befuddling tariff narrative, along with the broader macro policy uncertainty of a new administration, has created only a temporary setback for dealmaking. But policy predictability has improved. Throw in regulatory reforms, and that creates a catalyst for more M&A, especially in the banking sector, where mergers had faced significant regulatory hurdles in recent years amid a clampdown on consolidation among financial firms. 

The Trump administration’s looser approach led the Federal Deposit Insurance Corp. in March to approve a proposal to rescind a Biden-era policy that had put bank mergers under close scrutiny. While the rebound in optimism is palpable, it’s hard to predict timing, argues Bank of America’s Brandon Berman:

Reasons for M&A haven’t changed, and peak policy uncertainty has receded. The more accommodative regulatory environment is already leading to faster deal approvals. Valuation spreads are likely still too narrow but less of a hurdle vs. two months ago. 

The Senate’s approval of deregulation advocate Michelle Bowman as the Fed’s vice chair for banking supervision should set the ball rolling. Signs of her laissez-faire approach are evident in plans to reduce a key capital buffer by up to 1.5 percentage points for the biggest lenders to address concerns that it constrained their trading in the $29 trillion Treasuries market.

High expectations for Bowman. Photographer: Al Drago/Bloomberg

Gavekal Research’s Tan Kai Xian points out that the Fed has been waiting for Bowman to take up her post before releasing new supervisory ratings for US bank holding companies. She had criticized last year’s as overly strict. More accommodative ratings are expected on her watch.

Further, Bessent said on May 5 that “the growth of private credit tells me that the regulated banking system has been too tightly constrained,” implying the pace of bank deregulation could be aggressive. (After all, he could have concluded that private credit needed to be regulated more.) If so, US commercial bank earnings and stock prices will benefit. What’s more, the experiment will be closely watched in other jurisdictions. The sector’s share prices have never recovered from the regional banking crisis that followed the demise of Silicon Valley Bank in the spring of 2023, suggesting the classic conditions for larger predators to look for deals:

Beyond forecasting a return to deals, investors need to identify the targets, and also work out whether to bet on the potential buyer. Berman’s analysis backs the conventional market wisdom that acquisition targets consistently outperform buyers after deal announcements. This BofA chart highlights the distribution of bank mergers by size in the last 13 years:

In their review of the last 50 bank deals, Berman concludes that targets delivered significantly higher returns than buyers in the short, medium, and long terms following an acquisition. That isn’t to say buyers should be avoided, as they can outperform when the market views an acquisition as particularly strategic or attractively priced. Psychology ensures that there is always a risk that buyers will overpay, particularly in a competitive situation. Buyers only beat targets when they recouped the deal’s costs much faster than average.

—Richard Abbey

Survival Tips

Hotter than a match head. Photographer: Sam Wolfe/Bloomberg

More suggestions for heated music to get through the high temperatures. Try Hot Hot Hot by Buster Poindexter (formerly David Johansen of the New York Dolls), Hot Time by Triumph, Hot Child in the City by Nick Gilder, Summer in the City by the Standells, Hot To Go by Chappell Roan, Red Hot + Rhapsody and Morcheeba’s version of Summertime and Hotta by Sky. Stay cool, everyone. 

More From Bloomberg Opinion

• Matthew Winkler: Bond Traders May Have Found the Next Greece
• Marcus Ashworth: To Buy British, Think Bonds and Not Stocks
• Editorial Board: Federal Reserve Has No Alternative to ‘Wait and See’

Want more Bloomberg Opinion? OPIN. Or you can subscribe to our daily newsletter.

Like Bloomberg's Points of Return? Subscribe for unlimited access to trusted, data-based journalism in 120 countries around the world and gain expert analysis from exclusive daily newsletters like Markets Daily or Odd Lots.