Middle East headlines continue to drive markets, and there is a notable effort from the US – and its President – to ease tensions. Donald Trump has proposed a 5-day ceasefire to Iran earlier this week, he said he pointed at “productive and constructive” discussions with Iran – a claim denied by Tehran – and yesterday, he added that Iran had offered a “present” in the Strait of Hormuz. Nothing has been confirmed– to my knowledge – from the Iranian side. What is clear, however, is that Trump wants this war to end. Whether he can make that happen remains to be seen.
There are also reports that 3’000 troops are headed to the region. If boots hit the ground, the conflict would escalate.
I am not taking Trump’s words at face value, but his unilateral efforts offer some hope. Oil is lower this morning: Brent is down 3.70%, trading near $96pb at the time of writing, while WTI crude, which was lower earlier, is now up around 1.50%. Equity indices in Asia are pushing higher. The Nikkei is rebounding 1% after a flat session yesterday, the Kospi is up around 1.50%, while US and European futures point to a positive start.
But gains appear fragile, as the US dollar is pushing higher nonetheless. The USDJPY is up for a second session, again flirting with the 159 level. What keeps the pair contained near current levels is the fear of direct intervention from Japanese authorities to prop up the yen. That threat remains quite effective in discouraging speculative FX positioning.
Investor sentiment is cautiously improving on hope, but the fundamentals have taken a hit after almost a month of fighting in the Middle East and disruptions around the critical Strait of Hormuz. This is reflected in yesterday’s PMI data. Australia’s composite PMI slipped into contraction – below the 50 mark – while euro area private-sector activity grew at the slowest pace in almost a year, posting its biggest decline since the Ukraine invasion. Manufacturing activity across Europe – a smaller share of total activity – came in better than expected, but price pressures rose worryingly. In the UK, manufacturing costs rose by the most since Black Wednesday in 1992, according to the PMI survey.
One hope is that this month’s price spike proves temporary if tensions ease and oil prices decline sustainably. History offers some perspective – and hope. During the Gulf War, when Iraq invaded Kuwait in August 1990, oil prices surged from around $15 per barrel to nearly $40 in just two months, rattling global markets. But the stress was relatively short-lived. By the time coalition forces intervened and the war ended in February 1991, oil prices had already begun to moderate. Roughly one month later, volatility remained elevated; three to six months later, stabilization had begun, with energy markets largely returning to pre-war levels; and after one year, markets had broadly resumed prior trends.
If today’s crisis follows a similar path, oil prices could stabilize in the $80–85pb range in the coming months, while the US dollar could ease, offering a double benefit to global economies. Over a one-year horizon, oil could potentially return to the $60–70pb range. But there are many “ifs” in the near term, making short-term direction highly uncertain.
What is certain is that investors are eager for tensions to ease, hoping for a post-“Liberation Day”-type rebound in equity markets. I would argue that a rebound is likely, but the recent dip in US equities has not been as severe as last year’s selloff. The S&P500 fell more than 20% on tariff stress before rebounding last year; currently, it is down just over 7% from its January peak. Therefore, I wouldn’t rule out the possibility of a deeper correction before dip buyers return with conviction. After all, the Middle East situation today is worst than a week ago, with Gulf countries reportedly ready to join the war, and US troops headed to the region.
The macroeconomic backdrop has deteriorated over the past month. Energy prices are higher, operating costs are rising, and margins are likely to come under pressure. Expectations for the Federal Reserve (Fed) and other major central banks have shifted in a more hawkish direction, with markets increasingly questioning whether the Fed can deliver rate cuts this year.
At the same time, stress in private credit is building, while AI-related disruption continues to weigh on parts of the tech sector. The iShares Expanded Tech-Software ETF fell more than 4% yesterday, on news that Amazon’s cloud unit is developing AI tools to automate functions across sales, business development and other areas, potentially leading to further job cuts.
This raises another issue: AI-driven automation could lead to job losses – something the Fed may ultimately need to address through policy, given its dual mandate, unlike many of its peers such as the European central banks, which focus primarily on price stability.
Released this morning, UK inflation came in higher than expected. Headline inflation steadied near 3% in February but core inflation rose unexpectedly rose to 3.2%, both above the Bank of England’s (BoE) 2% target, and set to take a lift in the coming months due to the recent rise in energy prices. This expectation has already shifted BoE rate expectations. Last week, the BoE kept rates unchanged, whereas markets had expected a cut prior to the escalation in geopolitical tensions. Now, the BoE may be forced to maintain a more hawkish stance, and could even consider further tightening if price pressures persist.
This outlook is challenging for the government’s fiscal position, as well. Rising inflation expectations and a more hawkish BoE have pushed 10-year gilt yields above 5% earlier this week, the highest since 2008. Rising borrowing costs are eating into the fiscal headroom and brings two unideal scenarios on the table: if the government cuts spending, growth will suffer; if it increases support (through energy subsidies for ex), borrowing will rise. Neither outcome is particularly supportive for sterling.
Cable faces resistance near its 200-day moving average around 1.3430, while the EURGBP near 0.86 could act as a floor, despite a recent death cross formation favouring sterling. Both the euro and sterling are vulnerable to an energy shock, but sterling arguably more so, given the UK economy’s sensitivity to energy prices and relatively fragile fiscal position post-Brexit.
