Putting markets into perspective as Middle East tensions escalate

Markets ended last week under pressure after a significant escalation in the Middle East, as Israel launched airstrikes against Iran, targeting nuclear and military infrastructure. The strikes have heightened geopolitical uncertainty and led to a sharp uptick in oil and gold prices¹ as investors sought “safe haven” assets for their portfolios. Equity markets came under pressure, reflecting concerns about potential regional spillover and its implications for global growth and inflation.

Most telling, however, was the lack of reaction in the US dollar(USD), which only appreciated slightly.² Normally, one would expect a strong knee-jerk reaction in the USD to events such as these. The lack of movement emphasizes the much-reduced safe haven status that the USD now has.²

Markets have historically shown resilience during regional conflicts

While these developments are serious and warrant close monitoring, it’s important to maintain perspective. Historically, markets have shown resilience in the face of regional conflicts. For example, despite the initial shock of Russia’s invasion of Ukraine in early 2022, equities recovered and continued to rally in the years that followed.³ Similarly, since the onset of the Israel-Hamas conflict on October 7, 2023, markets have largely looked through the volatility, supported by strong corporate earnings and economic momentum.⁴

Unless a meaningful and lengthy hit to global oil supply takes place — which would require disruption in the Strait of Hormuz —  we believe oil prices would likely give back some of their immediate gains.

As we assess the current environment, we remain focused on fundamentals. While encouraging economic data, the possibility of rate cuts, and the potential for trade deals give us reasons to remain optimistic, we continue to focus on quality when navigating today’s market.  

This week’s focus:

· US economic data defies expectations

The US Consumer Price Index (CPI) for May continued to show limited signs of upward pressure from tariffs. Headline CPI inflation stands at just 2.4% on a year-over-year basis, while the closely watched “core” figure, which excludes more volatile food and energy prices, has run at a 2.8% year-over-year clip for three consecutive months.⁵ US payrolls in May also exceeded expectations, although the pace of job growth and downward revisions to prior months’ data pointed to a labor market that’s beginning to slow.⁶  Signs of emerging weakness can be seen in applications for unemployment benefits, where recurring claims recently hit their highest level since 2021.⁷

· “Good news” rate cuts come back into play for the US

Lower-than-expected inflation prints, accompanied by resilient yet cooling labor market data, may make it more difficult for the Federal Reserve (Fed) to justify remaining “on hold.” If tariff-induced price increases prove milder than initially thought, the Fed may begin lowering rates in response to “good” inflation news rather than waiting for “bad” employment data before deciding to cut.

· Global markets appear priced for expansion

US financial markets viewed last week’s inflation figures as a positive signal for the economy. Stocks rose⁸, and Treasury rates fell in reaction to the print,⁹ while the US dollar trended lower,¹⁰ likely in anticipation of potential rate cuts. Outside the US, a weakening of the USD, accommodative monetary policy, and room for greater fiscal policy support have led to a strong rally in non-US stocks, with the MSCI EAFE Index up 19% and MSCI EM Index up 14% year-to-date in USD terms, compared to the S&P 500 Index at 3%.¹¹

· Treasury auctions show strong demand

Recent concern about the US Treasury market appears to have been overblown. Last week saw solid demand for both 10-year and 30-year Treasury bonds,¹² following a marginally weaker-than-expected 30-year auction just a few weeks ago. More impressive was that demand remained strong despite a decline in US Treasury yields in the days leading up to last week’s auction, which suggests continued appetite for US debt at various levels of interest rates.

· Trade deals progress with China; escalate elsewhere

The US and China met in London last week to discuss an ongoing trade dispute related to export controls. Though details remain limited, a deal was reached in principle for the US to reduce restrictions on the export of advanced computer chips to China in exchange for China providing the US with a steady supply of rare earth minerals, which are vital for manufacturing. Elsewhere, however, President Trump announced that he intended to inform trading partners of unilateral tariff rates within the next two weeks, marking the potential for escalation following months of negotiation.

· Weaker UK labor market likely means more Bank of England rate cuts

UK labor data show that while companies aren’t actively laying off workers at a faster pace,  they’re hiring more slowly. The number of job vacancies fell further last week as companies seek to manage the cost of higher National Insurance contributions. Further, wage growth is now below the Bank of England (BOE) forecast, indicating less inflation pressure. This weakness in the UK labor market data points to faster BOE rate cuts than are priced by the market. This could mean lower mortgage rates for households and potential support for greater consumer spending.