Investment Viewpoint: Markets navigate rising geopolitical risks

Simplify the complex with clear and concise market insights direct from our investment experts every week.

Markets and macro insights with Bernard Swords, Chief Investment Officer

Key takeaways:

1. Rising Middle East tensions and higher oil prices weighed on markets, pushing global equities lower and driving bond yields higher.
2. The European Central Bank (ECB) raised rates and signalled further tightening may be ahead, while US inflation data reinforced expectations that interest rates could remain higher for longer.
3. Against this backdrop, we continue to favour equities over fixed income within portfolios. Within bond allocations, we believe maintaining a shorter-duration approach remains appropriate given the increased uncertainty surrounding future interest rate policy.

How did markets perform last week?

• Financial markets had a challenging week, with global equities falling by just over 1% in euro terms. Bond markets also weakened as investors adjusted to a changing outlook for inflation and interest rates. Government bond yields continued to move higher, with 10-year euro area bond yields rising above 3.5%, while equivalent US Treasury yields approached 5%. The main themes driving markets were higher energy prices, central bank policy decisions, and inflation data. All three developments contributed to increased uncertainty and weighed on investor sentiment.
• The most significant factor affecting markets was the escalation of conflict in the Middle East. Concerns about disruptions to global energy supplies intensified as tensions spread across the region. The continuing closure of the Strait of Hormuz and growing concerns surrounding shipping routes in the Red Sea have raised fears about the movement of oil and other commodities. As a result, Brent crude oil rose above $100 per barrel and remained at those elevated levels during the week.
• While the rise in oil prices is clearly a concern, it is important to remember that energy markets can move quickly. Any signs of a reduction in tensions or progress towards a diplomatic solution could lead to a sharp fall in oil prices and provide relief for financial markets.

What were the key economic developments last week?

• The European Central Bank (ECB) increased interest rates by 0.25% at its latest meeting, a move that was widely expected by markets. More importantly, the ECB also raised its forecasts for both economic growth and inflation in the coming years. These updated forecasts suggest that policymakers remain concerned about inflation pressures and could raise rates further. Our Chief Economist Dermot O’Leary now expects at least one additional ECB rate increase before the end of the year.
• In the US, investors closely watched the latest inflation reports. Producer Price Inflation, which measures inflation at the wholesale level, was broadly in line with expectations. However, Consumer Price Inflation came in slightly higher than forecast with core inflation at 2.4%. While this was somewhat above expectations, it remains significantly lower than the levels experienced during the post-pandemic inflation surge and is close to levels last seen before COVID-19. With the US Federal Reserve meeting this week, investors are increasingly focused on the path of future interest rates. Market expectations now suggest that further monetary tightening remains a possibility as policymakers seek to ensure inflation remains under control.

What does that mean for our positioning?

• Despite recent market weakness, we remain broadly constructive on the outlook for investors. Higher energy prices are undoubtedly a headwind for the global economy and are likely to push headline inflation higher over the coming months. However, at present, we do not believe oil prices have reached levels that would cause significant damage to economic activity or trigger a major downturn. The biggest impact of rising energy prices is likely to be felt in bond markets, where concerns about inflation can keep upward pressure on yields.
• As a result, we continue to favour equities over fixed income within portfolios. Within bond allocations, we believe maintaining a shorter-duration approach remains appropriate given the increased uncertainty surrounding future interest rate policy.

The week ahead: what to watch out for

This week the US Federal Reserve’s policy meeting will be the main focus for investors. Markets are currently expecting a further 0.25% increase in interest rates, but the guidance provided by policymakers regarding future rate decisions may prove even more important than the rate move itself.
Investors will also receive a range of economic data, including US retail sales and industrial production figures. Updates on industrial production from China and the euro area will provide further insight into the health of the global economy and whether economic growth is continuing to show resilience in the face of higher interest rates and elevated energy prices.