Japan's Nikkei 225 Index edged 0.1% lower to 62,666.57 after touching an all-time high of 63,385.04 earlier in the session, as Middle East crisis concerns resurfaced despite earlier optimism. The broader Topix climbed 0.23% to 3,838.26, with 139 advancers against 83 decliners in the Nikkei index. According to The Economic Times, Japanese shares erased early gains as U.S. President Donald Trump rejected Iran's response to a proposal for peace talks, dimming hopes for an end to the conflict that has driven up global energy costs. Nintendo was among the biggest decliners, down 6.5%, after the company hiked prices on its Switch 2 video-game console. However, shares of video-game maker Konami Group and Japan Tobacco were among top gainers after both companies posted strong earnings late on Friday.
The Federal Reserve's latest Financial Stability Report identifies the Iran conflict and resulting oil price shock as the primary threats to financial stability, surpassing other macroeconomic risks. According to The Economic Times, around three-fourths of survey respondents identified geopolitical risks as their top concern, while nearly 70% flagged the oil shock stemming from the conflict as a major threat to the financial system. The report warns that a prolonged conflict in the Middle East, especially if accompanied by disruptions to commodity supplies and supply chains, could reignite inflationary pressures and weaken economic growth globally. Global crude oil prices have surged more than 50% since the start of the U.S.-Israeli attacks on Iran on February 28, with benchmark prices remaining above $100 per barrel amid uncertainty over a potential peace agreement. Latest developments show Brent crude surged as much as 4.2% to $105.54 a barrel after President Trump rejected Iran's latest response, effectively prolonging the functional closure of the Strait of Hormuz.
Market analysis reveals that bond markets are pricing in a more dovish Federal Reserve response to the oil shock, with the Fed expected to look through the inflationary impact similar to how it handled 2021 price pressures. According to Investing.com, since the end of March, 10-year real yields have fallen while 10-year inflation expectations have risen, with nominal 10-year yields remaining roughly sideways. The CPI inflation curve shows May at approximately 4.2%, June at 4.0%, July at 3.9%, and August at 3.7%, with the shape heavily dependent on oil price movements. Markets have removed two or three previously priced Fed rate cuts while maintaining no hikes are priced in, indicating a different reaction function from the ECB and BOE, which are pricing multiple rate increases. Kevin Warsh's transition to the Fed chair remains a wildcard, with his dovish messaging prior to the oil shock potentially influencing current market expectations.
Oil markets opened the week like a pressure cooker with Brent crude surging as much as 4.2% to $105.54 a barrel after Trump rejected Iran's latest response, effectively extinguishing hopes for a near-term breakthrough. The near closure of Hormuz since the war erupted at the end of February has already choked off significant flows of crude, liquefied natural gas, and refined fuels, creating what the International Energy Agency describes as the largest supply shock in modern history. Brent's prompt spread widened toward nearly $4 a barrel in backwardation, an unmistakably bullish structure signalling immediate supply stress as refiners and traders scramble for nearby barrels. More than 4,000 lots of Brent's front-month contract traded within the first minutes of Monday's opening, roughly four times normal activity, underscoring how aggressively participants are repositioning around prolonged disruption risks. Higher gasoline prices dragged U.S. consumer sentiment to a record low in early May, with data showing the impact of elevated energy costs on consumer confidence.
Despite the retreat from record highs, capital investment in AI-related sectors is increasing, with the view that strong demand for these companies will continue to be a positive factor for shares, according to Nomura Securities equities strategist Wataru Akiyama. Wall Street climbed to record highs on Friday, underpinned by artificial intelligence-related stocks such as Nvidia and SanDisk, with the optimism carrying into Asia where Japanese chipmaker Kioxia jumped 6.8% on Monday after a 22% surge last week. The momentum in the sector remained strong, with the Philadelphia Semiconductor Index surging to an all-time high on Friday. However, Nintendo's 6.5% decline after price hikes on its Switch 2 console highlights the selective nature of the rally, as investors appear to be focusing on companies with clear AI-related business models over traditional gaming companies.
The Trump-Xi Jinping summit now carries far greater geopolitical significance as both leaders seek a path to contain the Iran conflict without appearing strategically weak. Trump enters Beijing looking for multiple wins simultaneously, wanting to stabilize markets, reduce economic drag from Hormuz disruption, and demonstrate that American pressure can force concessions without triggering broader regional collapse. China depends heavily on discounted Iranian oil flowing through this deeply transactional relationship, with any prolonged disruption threatening both Chinese energy security and broader export demand. Iran warned Britain and France that any additional naval deployments into the Strait of Hormuz would trigger what Tehran described as a 'decisive and immediate response' after London dispatched a warship to the region, raising fears that the waterway is steadily becoming less a commercial shipping lane and more a floating geopolitical tripwire.
