Whilst markets remain calm despite heightened geopolitical tensions, world leaders gather in Canada for the G7 meeting. Tom Stevenson, Investment Director, Fidelity International comments in the below piece:
“What doesn’t happen is sometimes as interesting as what does. Market reaction to Friday’s rise in geopolitical tensions in the Middle East was surprisingly muted. Such developments might traditionally trigger a classic risk-off response, sending investors in search of safe havens.
The dollar and US Treasuries hardly budged. This echoes the response to April’s tariff news. Investors are seeking shelter, but in different places. Gold, non-US equities, even bitcoin (although this retains some riskier characteristics) are the new homes for risk-averse investors.
Last week’s events in the Middle East did not significantly derail market sentiment. For now, it looks more like an energy issue than a broader economic concern. That said, the region will be top of the agenda for the G7 meeting in Canada.
Commodities and markets response
Oil prices reacted as expected, with prices jumping as much as 5.5% over the weekend before crude eased back as investors bet that hostilities would remain contained.
The stock market has taken it all in its stride. The S&P 500 was down just 0.35% last week, after a 1% drop on Friday, and the V-shaped recovery since April’s tariff-driven dip remains strong. Having fallen more than 20% from the February high, the US index is now within a couple of percentage points of the peak again. It’s an unusually strong rally by historic standards in terms of both scale and speed.
Does this mean the cyclical bull market that began in October 2022 is back on track? Only time will tell. The possibility that shares are in a broad trading range between the April low of below 5,000 and today’s high of just above 6,000 looks equally plausible.
One reason to suspect that’s the case is an absence of breadth in the rally. The number of stocks above their 20-day moving average is low and falling. The divergence from the still rising price level of the market indicates fragility.
At the same time, the bond market looks stuck. That’s because it’s caught in a two way pull between flat to falling interest rates on the one hand but a rising term premium on the other. The term premium is the extra yield that investors demand to lend for long periods and it is rising. Worries about inflation and uncertain policy mean they require more compensation to lend for, say, 30 years than for two.
The expected path of interest rates would suggest 10-year bond yields of between 3.5% and 4.2% while a rising term premium argues for yields of up 5.5%. At 4.4%, the 10-year is bang in the middle, sitting on the fence.
Earnings and valuations
The other important driver of share prices – earnings – is interesting at the moment too. Although, we’re in a summer lull from the perspective of results announcements, the trend of earnings forecasts is telling us something. While predictions are being reined in on the other side of the Atlantic, due to worries about the impact of tariffs, over here they are edging higher.
That could be an important consideration for investors looking at the relative valuations on either side of the pond. US shares have traditionally been higher rated than their European counterparts because US companies have been more profitable. But if the gap between the two narrows, so too might the valuation multiple. At the moment, US shares are priced at just over 20 times expected earnings and European shares in the mid-teens. Might they meet in the middle?
Central banks in the spotlight
Another focus this week will be central bank decisions with interest rate announcements due from the Federal Reserve, Bank of England, Bank of Japan and Swiss National Bank.
The Fed is expected to leave rates unchanged again at between 4.25% and 4.5% on Wednesday as it waits to see what impact US tariffs will have on inflation and growth. Markets are pricing in a couple of rate cuts by the end of the year, but chair Jerome Powell is resisting pressure from the White House to cut rates before the outlook is clearer.
The Fed’s caution follows a smaller than expected increase in US prices in May, with inflation at 2.4%. Goldman Sachs, which doesn’t think rates will fall until December, recently increased its estimate of US GDP growth from 1% to 1.25%, expecting a smaller impact from tariffs than it had previously thought. It has cut its recession risk from 35% to 30%.
Over here, the Bank of England is also expected to sit on its hands, sticking with its apparent preference for small cuts in alternate months. Since its May meeting, UK economic data has been weak. The economy had its sharpest contraction since 2023 in April and wage growth has slowed. Unemployment has edged higher and business confidence is fading. At the same time inflation remained above target at 3.5% and rising oil prices will only keep upward pressure on prices.
The outlook in Japan and Switzerland, meanwhile, is diverging. Japan has seen the yield on its long bonds hit a record high of over 3% as rising inflation and weak demand for bonds increases pressure on the Bank of Japan ahead of its rate-setting meeting this week. In Switzerland, however, the safe haven nature of the currency is pushing import costs lower and there is growing speculation that the Swiss National Bank may even consider pushing interest rates back into negative territory to fend off the risk of deflation.
Safe havens
Back to other safe havens, gold last week passed the euro to become the world’s second-largest reserve asset among global central banks. With investors looking for alternatives to the dollar and dollar-denominated assets like US Treasuries, gold has become a go-to safe haven again.
The price of gold surged to a record real high in April, overtaking the previous record set in 1980 when events in the Middle East were also on investors’ radars. The trajectory of the gold price has been very similar to that of the late 1970s and again during the financial crisis. Some of the conditions during those two periods – inflation, instability – are present today, but so too is a new factor – a growing lack of certainty about the central role of the US in the world and its financial infrastructure.
In 2025, gold has outperformed all major asset classes – thanks not only to its safe haven appeal, but also its liquidity and reserve status.”
