Recent developments between Israel and Iran prompted an initial, and largely expected, market reaction, with analysts closely watching for signs of further escalation. At the same time, economic updates from the US and UK continue to keep investors on alert. Our Chief Investment Officer, Richard Flax, explores the key international events and what they could mean for markets and portfolios.
Geopolitical tensions escalated as Israel attacked a number of sites in Iran, targeting Iran’s nuclear programme. The immediate market reaction has been as expected – equities weakened, commodities like gold and oil rallied and there was an initial ‘flight to quality’ towards government bonds.
We think the market reaction has been fairly muted so far, with S&P 500 futures down a little over 1% as of mid-morning in Europe. We think this reflects the recent market experience with geopolitical tensions, where, after an initial reaction, investors have largely looked past the potential risks from conflict. While that’s worked out well in the past, it’s not certain that will always be the case. We think the key question remains around escalation – will this prove to be a relatively isolated move, or will we see the conflict expand? It’s something we’ll continue to monitor closely in the coming days, especially given the various ways geopolitical tensions can influence financial asset prices.
These effects can manifest in several forms first, through a general rise in uncertainty, which often leads investors to move away from riskier assets amid concerns over global conflict. Second, in this case, there’s the risk to oil supply. Supply disruptions can impact prices and, over time, feed into inflation and underlying domestic demand. It could be an additional headwind, following on from the ongoing global trade tensions.
In terms of portfolios, we’re generally comfortable with our positioning. We think our portfolios are well-diversified and positioned slightly conservatively. We’ve maintained our commodity exposure across most lines, which should provide some support during a period of heightened geopolitical uncertainty. We’ll continue to evaluate the current environment and make any adjustments we think are necessary to maximise long-term returns.
Inflation in focus in the US
Following the so-called ‘Liberation Day’ – when significant US tariffs on key trading partners came into effect – many investors (including us) wondered how the new environment would affect the global economy. There was a rough consensus that higher tariffs would be negative for economic growth. There was less consensus around inflation.
The initial impact might be for inflation to rise, but if demand weakened, then higher inflation might prove short-lived. The next question was when would we begin to see these changes, taking into account global supply chains, pre-emptive buying ahead of the announcement etc. It wasn’t clear, but there was a view that we might start to see the impact in May.
The result of all that has been that the May inflation data in the US has gotten a lot of attention this week. In the end, both consumer and producer prices came in lower than economists had expected – which overall should be taken as good news.
What’s interesting is that the better-than-expected results haven’t really changed investors expectations for the path of policy interest rates. Based on current pricing, investors don’t expect any change at the latest meeting in June, and are still looking for around a 0.5% reduction over the rest of 2025.
We think that suggests that investors aren’t convinced about the impact of tariffs on US inflation, expecting to see inflation pick up later in the year, despite the subdued May report.
UK eyes on spending and growth
There was a familiar refrain in the UK this week. The Chancellor Rachel Reeves announced her spending review, with an emphasis on healthcare, housing and defence. As usual, the responses ran the gamut from “not enough” to “far too much”.
From an investor perspective, the question remains how will the government pay for all this? Earmarking spending as investment helps with the fiscal rules – and should help to support future growth – but the deficit will still need to be funded. In that regard, news that the economy contracted in April compared to March – despite still growing year-on-year – was unhelpful.
We’re wary of making too much of monthly GDP numbers, but the economy remains fairly weak and that’s not great for tax revenues. We’d expect the Chancellor to look to raise taxes in the autumn.
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