Middle East Conflict Keeps Casting a Shadow Over Financial Markets

Markets

The Middle East conflict keeps casting a shadow over financial markets, affecting literally every asset class. Channels through which are multiple. Risk premia and inflation (expectations) batter long-term government bonds. The impact of significantly higher rates on already fragile public finances acts as an accelerant. The UK last Friday was case in point with a batch of very poor deficit numbers adding more pressure to gilts. The worrying thing is that the February figures pre-date the Iran war, so they are not even taking into account the increased interest rate burden nor the potential fiscal response to higher energy prices. The UK 10-yr yield briefly topped the 5% barrier Friday for the first time since 2008. German yields in the 10-30 yr bucket added 7.3-8.1 bps with the 10-yr closing at the highest level since 2011 (3.04%). Treasuries underperformed by rising 10-13 bps in the same segment. The front end of the curve meanwhile is positioning for rate hikes. The ECB and especially the Bank of England, both scarred by the 2022 energy crisis, showed they are ready and willing. UK short-term rates soared 16 bps. The US and Germany joined the move higher with 11-12 bps and >8bps respectively. Money markets are pricing in more than three hikes this year by the ECB and BoE while any remaining rate cut bets in the US have swapped for a 60% hike chance by end of this year. US president Trump’s 48-hour deadline issued on Saturday is bound to keep core bonds at all maturities under pressure at the start of another potentially explosive week. Trump on Saturday demanded the Strait of Hormuz to be fully open and without threats or Iran would have its power plants bombed. Iran has shown little intention of complying. Oil prices react by moving higher. Brent is currently trading around $113 per barrel. Stagflationary vibes meanwhile are hurting risk assets. The EuroStoxx50 (-2% on Friday) lost key support from the pre-Liberation Day high (5568.2) and the 23.6% retracement on the rally that followed the now infamous April 2. The S&P500 (-1.5%) is at a key technical juncture around 6500. Losses on Asian stock markets this morning are suggesting more pain is inbound. The US dollar is the preferred currency still but truth be told: it isn’t steamrolling its peers either. USD/JPY does close in on the crucial 160 barrier, hovering near the levels that prompted (market) talk of a coordinated US-Japanese FX intervention. EUR/USD lost three big figures from 1.18 since the war erupted but since then traded sideways around the 1.15 lever. For sterling it seems that the significantly widening interest rate differentials are losing relevance as a GBP driving factor. EUR/GBP is bottoming out north of 0.86.

News & Views

Rating agency Standard and Poor’s on Friday raised Ireland’s credit rating to AA+ from AA with a stable outlook. The move was driven by stronger economic and fiscal profiles. Despite rising global trade protectionism, Ireland’s domestic economy has expanded by close to 5% on average for 5 consecutive years. Given the economy’s extreme openness (exports equivalent to 144% of GDP), it will remain sensitive to external shocks and decisions of a handful of multinational companies. Even so, S&P assesses that ‘the economy’s diversity, the significant fiscal and economic buffers, the sound policy settings, and membership in the EU and the euro area will help authorities shield households and companies from a slowdown in global growth, a withdrawal of foreign direct investment, or deteriorating terms of trade’. The government has taken advantage of recent economic success to rebuild fiscal buffers and S&P sees budget surpluses at an average of 1.3% of gross national income (GNI) over 2026-2029. Net government debt furthermore has fallen to 43% of GNI in 2025 from 96% of GNI in 2020.

In an address at the China Development forum in Beijing on Sunday, Prime Minister Li Qiang addressed the concerns of trading partners on China’s lager trade surplus. He confirmed the country’s intention to further open its economy and to work to promote a more sound and balanced development of trade. In this perspective, he indicated that China would further widen market access for the services sector, and increase imports of medical and health care products, digital technologies and low carbon services to provide more business opportunities for foreign companies. The ‘commitments’ came as China last year posted a record $ 1.2 trillion trade surplus last year. At the same event, PBOC governor Pan Gongsheng put the impact of the large current account surplus into perspective as he said that is allocated to different regions and industries worldwide through foreign investment. In this respect he sees it as underpinning global economic growth and financial stability. The PBOC governor also indicated that China has no intention to gain competitive advantage of a currency depreciation.