Financial markets continue to digest the economic fallout from the Middle East conflict, with global inflation taking center stage. Central bank governors in the US and Europe are signaling greater caution, while optimism over a potential US-Iran deal is pushing oil prices lower and lifting equity sentiment.

Fed's Kashkari: Neutral stance needed, inflation is the bigger risk

Minneapolis Fed President Neel Kashkari told the Financial Times today that the Fed should adopt a neutral policy outlook going forward. "The risk to US inflation is now higher than the risk of labour market deterioration," he said. Kashkari, who dissented against the dovish language in the Fed's April rate statement, emphasized that the inflationary shockwave from the Middle East war could prove persistent.

Kashkari noted "an inflationary shockwave sent across the globe from the Middle East war" that "could persist," and said concern over global inflation is already filtering into the bond market. He said it's far too soon to predict the next Fed move, and that he wants to see how US-Iran negotiations play out and how global supply chains respond.

Meanwhile, Citadel Securities warned the Fed risks falling behind the curve as the inflation threat grows, while TD Securities maintains a bearish dollar view despite strong US data. The 10-year US Treasury yield edged lower to 4.49%, down from 4.56% on Friday.

ECB prepares for a June rate hike

Bank of France Governor Francois Villeroy de Galhau told CNBC the ECB will do "whatever it takes" to bring eurozone inflation back to its 2% target. His remarks follow April inflation data showing consumer prices rose to 3%, up from 2.6% in March — a sharp jump from 1.9% before the Iran conflict began on February 28.

The ECB held its key rate at 2% at its last meeting, citing insufficient data on second-round inflation effects. But markets are now pricing in a rate hike at the June 11 ECB meeting, with at least 50 basis points of tightening expected by year-end, per LSEG data.

Bundesbank President Joachim Nagel said oil price volatility has left the ECB navigating between its baseline and adverse scenarios. Latvia's central bank governor Martins Kazaks warned of a potential stacking of simultaneous economic shocks. The German 10-year Bund yield has risen roughly 32 basis points since the conflict began.

Europe: French consumer confidence plunges, German tax revenue slumps

French consumer confidence tumbled to 82 in May, the weakest reading since March 2023. Since the start of the Iran conflict, the index has fallen 9 points in three months — the steepest three-month decline since 2022. The sub-index on major purchase intentions fell to -40, far below the long-term average of -16.

In Germany, total tax revenue for the first four months of 2026 fell 2% year-over-year, reflecting deepening industrial and fiscal weakness across Europe's largest economy.

Markets: Oil falls, stocks rise on Iran deal hopes

WTI crude oil dropped about 4% to $90.15 per barrel as optimism grew over a US-Iran framework deal that could reopen the Strait of Hormuz. Reports indicate advanced negotiations on a memorandum of understanding that would include a ceasefire and Hormuz reopening within 60 days.

Equity markets are responding positively. The S&P 500 (tracked via SPY at $750.6) closed at a fresh record, and Nasdaq 100 futures rose 0.4% to extend all-time highs. Goldman Sachs raised its year-end 2026 S&P 500 target to 8,000 from 7,600.

The Israeli shekel strengthened against the dollar, with USD/ILS falling to 2.836 from 2.88 in recent days. The dollar index DXY edged lower to 99.07. Gold traded around $4,523 per ounce, supported by ongoing geopolitical uncertainty.

Why it matters

Bond and currency markets are repricing inflation risks globally. Fed and ECB hawkish signals suggest interest rates may stay higher for longer than markets had anticipated. At the same time, optimism over a potential Iran deal is providing a tailwind for equities and weighing on oil prices — a combination that keeps investors with one foot in and one foot out.

The bottom line

Wednesday brings a "buy the rumor" mood to markets — policy optimism alongside central bank warning signs. The key event ahead is the ECB's June 11 meeting, which could be the first in a series of rate hikes. Locally, the shekel's strength reflects relative optimism, but any renewed escalation in the Middle East could flip the picture quickly.