Starting with equity markets, which are behaving as one would expect. There are multiple factors at play, all conspiring against risk appetite. Downward pressure on stocks started weeks ago amid growing concern about an overinflated tech sector. The events in the Middle East over the past week have compounded selling pressure across the globe.

Meanwhile, the response in commodity markets has been mixed. Oil prices hit the headlines having rallied aggressively in recent days – front-month brent hit a high of $118 p/b in the early hours of 9 March, before retreating below $90 in the wake of the US President’s comments about the war being almost over. During times of crisis, gold prices would typically be expected to rise, but the opposite has been true over the past week, with the world’s traditional safe-haven asset showing a positive correlation with equities. This is probably a reflection of the sharp rise in prices in recent months and positioning being overextended.   

Turning our attention to interest rates, while central banks would like to cut rates to ease pressure on global growth, markets are suggesting otherwise, with yields rising across the curve. Rate cuts from the Bank of England this year have almost been priced out amid concerns about rising energy prices and their impact on inflation. The US economy is slightly better insulated from rising oil prices; the market is now only anticipating two cuts from the Fed this year, as opposed to three a couple of weeks ago. Further down the curve, the risk of higher rates is also evident, especially if the conflict is drawn out and government spending increases dramatically beyond forecast.

Perhaps the most notable response has been in FX markets, not because of the extreme volatility, but rather because of the lack of it. The dollar seems to have reverted to its traditional safe haven status, gaining ground as risk appetite dwindles. However, what is slightly unusual is that Treasuries remain under pressure, implying the ‘sell America’ trade is still a factor. Interest rate differentials have played less of a role, with currencies instead becoming more closely linked to oil. Currencies of net oil-exporting countries have notably outperformed those of net importers. 

The impact on forecasts

A common question amongst our clients has been how these developments are influencing our forecasts. Trying to predict when the war will end seems futile. Instead, a more pragmatic approach would be to consider a couple of risk factors:

• The dollar looks set to remain firm for now, at least until an end is in sight. The US President’s suggestion that the war with Iran could be over ‘very soon’ has given a boost to risk appetite and seen the dollar weaken again. If this initial optimism is justified, there is plenty of scope for the dollar to weaken further as recent patterns reverse - any such move could unfold quickly.
• A swift resolution would likely cause rates to fall and allow central banks to confidently look through any short-term disruption that would trigger inflationary pressures. However, the longer the conflict persists, the greater the pressure on the world’s central banks to guard against inflation. Thus far, very little has been spoken about the direct cost to governments of going to war. In her Spring Statement, UK Chancellor Rachel Reeves set out £28bn of headroom, but additional borrowing seems inevitable if the situation persists. At what point markets start punishing governments for additional borrowing remains to be seen, but the UK and sterling feel most susceptible given recent history.

Overall, our long-term bias for a weaker dollar remains the core theme underpinning our FX forecasts. However, the conflict in the Middle East is in currently in a state of flux. By the time you’re reading this, the situation and risks may have changed again. This highlights the challenge we face as risk managers, regardless of the underlying risk we’re facing. Ultimately, it’s a reminder of the importance of identifying, quantifying, and understanding the risk to facilitate the design of a robust framework around which it can be managed. After all, risk management isn’t about predicting shocks; rather, it centers on building resilience around them.