When Bad News Becomes Good News for Markets

For the past several weeks, financial markets have been driven less by economic data and more by developments in the Middle East. Every military strike between the United States and Iran, every threat to the Strait of Hormuz and every escalation in rhetoric has added another layer of uncertainty to the global economy. Oil prices moved higher, the US Dollar strengthened as investors sought safety, and risk assets came under pressure as markets priced in the possibility of a wider regional conflict.

This weekend, however, the narrative began to change.

Rather than waking up to further military escalation, investors were given something they have been waiting for: diplomacy. Reports that the United States and Iran are once again exploring ceasefire negotiations have prompted markets to reassess the geopolitical risk that has dominated sentiment throughout recent weeks.

It’s important to understand that markets don’t wait for peace to be signed. They simply price the probability of what comes next.

The prospect of diplomatic progress has already started to unwind some of the geopolitical risk premium that had built up across financial markets. Oil prices have eased as concerns over supply disruption through the Strait of Hormuz begin to fade, while investors have become more willing to move back into equities and higher-risk assets. At the same time, demand for traditional safe havens, particularly the US Dollar, has softened as capital begins rotating back towards currencies that typically benefit from improving global sentiment, including Sterling and the Euro.

Whether that move proves sustainable will depend entirely on how negotiations develop over the coming days. One positive headline could extend the current relief rally, while any indication that talks have stalled or broken down could quickly reverse much of the recent optimism.

Against that backdrop, this week’s economic calendar almost becomes secondary. There are several important releases across the UK, Europe and the United States, but their market impact will ultimately depend on whether geopolitical tensions continue to ease or suddenly flare up once again. As has often been the case this year, politics looks set to dictate direction, with economics providing the supporting evidence.

The week begins relatively quietly, with US Durable Goods Orders expected to slow to 0.9%. While this is not typically a major market-moving release, it does provide another indication of whether higher input costs, tariffs and ongoing uncertainty are beginning to weigh on business investment. If the figures disappoint, markets may begin questioning the resilience of the US economy heading into the second half of the year.

Attention then shifts firmly to the United States on Tuesday. ADP employment figures, the House Price Index and Conference Board Consumer Confidence will offer another health check on the world’s largest economy ahead of Friday’s Non-Farm Payrolls report. Individually these releases may not generate significant volatility, but collectively they will help shape expectations around the labour market and consumer spending, two areas the Federal Reserve continues to watch closely.

Wednesday is undoubtedly the headline event of the week as the Federal Reserve announces its latest interest rate decision. No change in policy is expected, meaning the focus will fall squarely on Chair Kevin Warsh’s second meeting at the helm and, perhaps more importantly, the updated economic projections and dot plot. Markets continue to debate whether another rate increase remains likely before year-end, particularly after the recent geopolitical tensions and the inflationary risks associated with higher energy prices. Any shift in the Fed’s language around inflation, growth or future policy could have a significant impact on both the US Dollar and global equity markets.

Thursday brings another busy session, beginning with a broad range of Eurozone data including GDP growth, Economic Sentiment, Consumer Confidence and Industrial Sentiment. These releases should provide a useful snapshot of how the European economy is coping with ongoing geopolitical uncertainty and elevated borrowing costs.

The focus will then turn to the Bank of England. While policymakers are widely expected to leave interest rates unchanged, the decision itself is unlikely to be the biggest driver of Sterling. Instead, investors will dissect the voting split, meeting minutes and accompanying guidance for clues on the path of interest rates over the remainder of the year. Markets continue to price one or two further rate increases, so any indication that the MPC coverage" class="tcb-autolink">Monetary Policy Committee is becoming more concerned about persistent inflation, or alternatively a slowing economy, could prompt a meaningful move in the Pound.

The week concludes with US Non-Farm Payrolls, still one of the most influential economic releases each month. Employment growth, wage inflation and the unemployment rate will all be watched closely as markets continue to assess the strength of the US economy and the likelihood of further Federal Reserve tightening. Alongside payrolls, investors will also digest the latest ISM Manufacturing data, providing another indication of whether activity across the industrial sector is beginning to recover or continues to soften.

Outlook

The biggest question facing markets this week is not whether inflation rises by a tenth of a percent or whether GDP beats expectations. It is whether the shift from military confrontation towards diplomacy continues.

If negotiations between the United States and Iran gather momentum, investors are likely to continue reducing the geopolitical risk premium that has supported the US Dollar and energy markets over recent weeks. That environment would generally favour a recovery in risk assets and provide further support for currencies such as Sterling and the Euro, both of which benefit from lower energy costs and improving investor confidence.

However, markets remain extremely sensitive to headlines. A single setback in negotiations, renewed military action or further disruption around the Strait of Hormuz could quickly reverse the optimism that has started to build and send investors back towards traditional safe havens.

As always, markets move on expectations rather than certainty. By the time a ceasefire is formally agreed or negotiations break down completely, exchange rates will already have adjusted. For anyone with upcoming currency requirements, the value often lies in understanding what markets are pricing next, rather than reacting to yesterday’s headlines.