Looking at last week’s market moves, you would be hard pressed to guess that the long feared full-scale war between Israel and Iran had broken out. Global equities were down all of 0.5% or so in both local currency and sterling terms. Furthermore, European equities are up a little this morning and even Israeli stocks are up since the attack.
As for safe havens, government bonds returned around 0.5% over the week on the back of a modest 0.1% drop in yields. Gold was up 3% but most of the move happened before Friday and is just back close to its April/May highs.
The only real give-away was the oil price which rose close to $10 to $74/bbl. But this jump only returns oil to around its levels in the spring and still leaves it towards the bottom end of the range of the last couple of years and well below the high of $120/bbl seen when Russia invaded Ukraine.
Is the market right to be so complacent? Looking back at history, you would have to say it is. The big lesson from past crises for investors is ‘keep calm and carry on’. In the past, an investor with a medium risk portfolio would always have been significantly better off remaining invested over the following three years following a geopolitical or economic shock, rather than fleeing to cash (even if they had perfect foresight and sold up just before the crisis broke). Even over one year, the right strategy was generally to remain invested.
If there is a full-blown recession, the picture changes. So, the key question, as it has been all year, is whether the latest developments threaten a recession. The risk here comes from oil and the danger that Iran tries to close the Strait of Hormuz, through which around 20% of global oil supply is transported. This risk cannot be dismissed out of hand, particularly with Israel and Iran now targeting each other’s energy infrastructure. The strait’s closure might well push oil above $100/bbl but the world is much less oil dependent than it used to be.
Even in 2022, when oil spiked to $120/bbl and the Fed was raising rates aggressively (unlike now when it is on hold and unlikely to increase rates at all), we escaped a recession. While the war does reinforce the case for continued market volatility over coming months – this was already looking likely given the sharpness of the recent market rebound and the continued uncertainty over tariffs – it is not a reason to sell up as we are still most likely looking at just a marked slowdown in US growth rather than a recession.
Talking of tariffs, there was some good and bad news last week. The good news was that the US and China agreed a deal to restore the current 90-day trade truce which had been in danger of breaking down. China will relax its controls on rare earth exports and the US ease restrictions on tech exports.
Less good, but arguably not a surprise, was Trump’s announcement that he will be letting US trading partners know in the next couple of weeks the ‘take-it or leave-it’ reciprocal tariff rates they will be facing after the 90-day negotiation period ends on 8 July. Coming weeks should therefore leave us a bit clearer on whether the correct moniker for Trump is ‘Tariff man’, as the man himself would have us believe, or ‘TACO man’ (Trump Always Chickens Out) as the markets currently seem to think.
Moving onto recent macro data, the latest US numbers were encouraging up to a point. The May inflation data undershot expectations with little sign as yet of any significant impact from the tariff hikes. The headline rate edged up to 2.4% while the core rate was unchanged at 2.8%.
US consumers also turned significantly less gloomy in June – they too apparently believing in TACO man. The consumer has also cheered up in China with retail sales growth in May hitting its highest level since 2023.
Here in the UK, the Chancellor’s spending review grabbed the headlines but with the overall spending numbers set back in March the implications for the economy overall (as opposed to particular sectors) were limited. Importantly, the major boost to public investment should longer term help improve the economy’s dire productivity performance, even if the short-term boost to growth is limited.
Meanwhile, the Chancellor did nothing to ease fears that some further limited tax rises are likely to be necessary in the Autumn to hit the fiscal rules, which she claims are non-negotiable.
On the data front, UK GDP contracted a larger than expected 0.3% in April. However, this follows a strong performance in the first quarter and the outlook remains for continued albeit sluggish growth. Meanwhile, the labour market showed further signs of weakening and underlying wage growth slowed in April to 5.2% from 5.6%.
This week, we have the G7 summit in Canada. Rather more important for markets will be developments in the Middle East and the meetings of the Federal Reserve and Bank of England on Wednesday and Thursday. The war only increases the uncertainty over the economic outlook and should make both central banks even more inclined to keep policy on hold for the moment.
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