Middle East Conflict; Central Banks

Market Overview

Given the scale of what unfolded last week: a major Middle East conflict, a fragile ceasefire clock, Trump’s tariff threats on standby, and multiple central bank meetings, it’s remarkable how little markets seemed to care. Equity indices drifted quietly, most ending the week on average only marginally lower. Bond yields barely budged. Whilst the oil price has risen to around $75 a barrel, even that move looks subdued, considering Israel and Iran continued to fire missiles at each other.

Perhaps investors have learned to tune out the noise. Or possibly, with gold richly priced, bond markets jittery over tariffs and deficits, and equities still offering relative appeal, they’re sticking with what’s worked since 2008, namely buying the dip. Retail investors, in particular, continue to pounce on weakness, a strategy that has consistently paid off since the Global Financial Crisis. But this may be more than just muscle memory. Confidence is building that inflation has peaked, OBBA stimulus is likely coming, and rate cuts from the Fed are probably now a question of when not if. For now, markets seem content to assume that the Middle East conflict will remain contained and that the global economy will continue largely undisturbed.

That’s no small act of faith, given events. Israel has escalated its strikes against Iranian targets, including the Isfahan nuclear site, while Iran has continued missile launches in response. Though there have been no confirmed casualties or leaks of hazardous material, the risk of miscalculation remains high. The White House is still walking a geopolitical tightrope. After initially giving diplomacy a two-week window, Trump hinted he might support a ceasefire but also signalled he could shorten deadlines. Meanwhile, Iran has insisted it won’t resume negotiations unless Israel halts its attacks, something Israel has firmly rejected.

European diplomatic efforts in Geneva have yielded little so far, and Tehran is instead pivoting toward regional players, such as Turkey. As of Sunday afternoon, the White House played its hand more openly, aligned itself with Israel, and, via the use of 14 ‘Bunker Buster’ warheads, has claimed, in the words of Pete Hegseth, to have “Devastated the Iranian Nuclear program”. In the same speech, he clarified, “We’re not at war with Iran. We’re at war with Iran’s nuclear program”. Trump’s message is simple; “negotiate or expect more strikes.”

Fed Update

Away from the battlefront, attention returned to central banks specifically, whether policymakers are finally ready to declare victory over inflation or at least loosen their grip. At this week’s FOMC meeting, the Federal Reserve left interest rates unchanged, as widely expected. But the devil was in the dot plot. While the Summary of Economic Projections kept the door open to two cuts in 2025, the underlying consensus has begun to fracture. More members are now leaning towards fewer cuts, reflecting doubts about whether inflation is truly tamed.

Chair Powell admitted that tariffs complicate the outlook. The Fed is trying to peer through the fog of geopolitics and trade policy, but tariffs affect both sides of the equation, dampening growth and lifting prices. It’s the classic stagflationary squeeze, and it’s why Powell and his colleagues are keeping rates high for now.

In another twist to the Fed–White House psychodrama, Trump took a swipe at Jerome Powell again last week, calling him ‘stupid’ for not slashing rates in the face of rising tariffs and Middle East instability. Powell, who rarely engages in political back-and-forth, no doubt has his thoughts on who the stupid one is but kept to the script, stressing the Fed’s data dependence and refusing to be drawn into campaign theatrics. Enter Christopher Waller, one of Trump’s appointees to the Fed Board, who broke ranks with Powell by suggesting that rate cuts could begin as early as July. It was a notable shift, especially as Waller has generally aligned with Powell’s cautious stance until now.

Waller’s comments briefly lit a fire under rate-cut expectations, but the bond market wasn’t buying it. Yields moved higher, a sign that investors view sticky inflation as a greater concern than any political pressure or dovish outliers on the FOMC. The Fed’s centre of gravity still leans toward holding steady, worried more about reigniting price pressures than tipping into recession. That may be defensible in the short term, but history suggests the Fed often sticks with its stance too long, only to pivot when the damage is already done. Housing is already flashing amber, and if cracks emerge in the Jobs data, there is a risk that Powell waits too long for confirmation while the real economy quietly stalls. For the moment, I think they are right to hold where they are, but the pressure to cut is likely to build as we get more hard data releases that are likely to point to a slowdown.

BOE & UK Economic Update

The Bank of England held rates steady at 4.25% this week, as widely expected, but the tone of the minutes and the split vote (6 in favour of holding, 3 for cutting) made clear that the bias is shifting towards easing. After months of hawkish hesitation, the MPC now seems more confident that the labour market is softening and that wage pressures are abating. The acceleration in job losses across lower-paid sectors, particularly those hit hardest by recent hikes in National Insurance Contributions and the National Living Wage, is ringing alarm bells. With vacancies falling and a rise in underemployment, the Bank now sees ‘clearer evidence’ of slack re-emerging. While headline inflation ticked down only marginally in May, the Bank’s preferred gauge of services inflation, stripped of airfares and other volatile components, continued its descent, reaching its lowest level in over three years.

With only one more inflation and jobs report due before the next MPC meeting in August, the path now looks clear for a rate cut, barring any upside surprises. A further move in November seems likely, and a third cut before year-end is now a growing possibility, especially if job losses mount and GDP growth continues to flag. Retail sales plunged in May, unwinding earlier strength, and Q2 GDP data looks set to disappoint, though I can’t help but feel it understates the actual strength of economic activity. But from the BOE’s perspective, the greater risk may be doing too little, too late. The three dovish MPC members have made that case explicitly; the rest of the committee may soon follow.

With the prospect of rate cuts looming, always good news for our housing-dependent economy, there are reasons to believe our equity market can continue to perform well on the world stage this year.  While the economy remains subdued, inflation is expected to cool as energy bills decrease later in the year. As mentioned, the BoE looks almost sure to begin cutting rates in August. That shift in monetary stance could come as global investors rediscover the appeal of overlooked markets, with money flowing out of the US. The UK, with its deeply unloved and undervalued equities, stands out.

The chart below, courtesy of J.P. Morgan, makes the point clear. The UK FTSE All-Share is trading at just 12.4x forward earnings, well below its long-term average of 13.8x. Relative to the US, the UK remains on a steep discount across almost every sector. Consumer discretionary, materials, and utilities all trade at valuation gaps of over 30%.

Meanwhile, the consumer is not as fragile as headlines might suggest. Household balance sheets remain in decent shape after years of precautionary saving, and falling mortgage rates could ease pressure at the margin. Wage growth, though moderating, still outpaces inflation, helping to support real incomes. As rate cuts begin to filter through, domestic activity could stabilise and eventually re-accelerate. Add to that a growing wave of foreign takeovers of UK-listed companies, and you have a market that global investors are starting to notice again. The pessimism that has weighed on UK valuations is beginning to look overdone. For the first time in a long while, the macro, policy, and valuation story may all be aligned in the UK’s favour!

Japan: Shifting Gears, Gently

The Bank of Japan held rates steady last week at 0.5%, but the real focus was on its carefully choreographed exit from quantitative easing. After a spike in ultra-long bond yields rattled local markets, the BoJ opted to slow the pace of JGB purchase reductions from FY2026, reassuring bond markets while signalling that the era of ultra-loose policy is entering its final stretch. It’s not a pivot to tightening but more a cautious retreat from the extreme.

This fits with a broader narrative: Japan is evolving, but slowly. The domestic economy remains in low gear, with consumption soft and real incomes barely moving despite headline-grabbing wage settlements. Inflation is running above target, but not for reasons that justify rate hikes. April’s price spike was driven by rice, not demand, a reminder that the inflationary story is still largely supply-led. Services inflation remains tame, and the BoJ sees no urgency in pushing rates higher. Barring a sharp reversal in US trade policy or a collapse in uncertainty, the next rate hike looks more likely in 2027 than in 2025.

That economic caution is reflected in earnings outlooks. The corporate sector has proven resilient, with FY2024 profits up 7.3% and wage growth solid across firms of all sizes. But external headwinds are gathering. Tariff uncertainty is weighing on export and investment plans, and Japan’s high sensitivity to global capital expenditure cycles leaves it vulnerable. While wage gains are sticky, real income growth is not limiting the firepower of the domestic consumer.

Still, equity markets remain firm. The TOPIX has risen alongside earnings with valuations undemanding by global standards, and corporate reform continues to underpin margins and buybacks. The long-term structural story of better governance, stronger returns on equity (ROEs), and greater foreign interest remains intact but is less enticing now. A fragile macroeconomic environment, fading global trade, and a central bank stuck between the fear of volatility and the desire for normalisation all point to a market that may be consolidating at these levels for the time being. That said, Japan’s transformation story isn’t over, although investors may need to be patient before the next leg higher.

This week…

All eyes will be on inflation data to guide the next moves from central banks. In the US, Friday’s Core PCE print is the key event – a softer reading could help revive talk of a September Fed cut, though recent sticky CPI and cautious Fed commentary mean markets may need convincing. In Europe, the Eurozone flash CPI is also released on Friday, providing an essential update on disinflation progress and the ECB’s policy direction. Meanwhile, Japan’s Tokyo CPI will provide an early read on whether food-driven inflation is easing, reinforcing the BoJ’s patient stance.

Germany’s ifo survey (Mon) will test whether sentiment is holding up after soft industrial data. US durable goods orders (Thu) will be closely watched for signs of weakening investment amid trade tensions. In the UK, CBI retail sales (Tue) give an early look at June’s consumer picture after a soft May. China’s industrial profits (Thu) will shed light on corporate momentum after better-than-expected activity data earlier this month.

It’s a quieter week on the earnings front, but a few key names are worth noting. FedEx (Tue) will be a global trade bellwether, especially in the context of ongoing tariff disruption. Nike (Thu) will offer a snapshot of US consumer strength and trends in China demand. European focus will be on H&M (Thu), which gives a read on discretionary spending and cost pressures in retail.