Three months into the Middle East conflict, the global economy has transitioned from the initial shock phase and into a more complex adjustment period. While oil prices have retreated roughly 20% from their conflict peaks on hopes of a diplomatic resolution, they remain structurally higher than their pre-war levels.
Despite the pullback in crude prices, volatility across equities, bonds, currencies and commodities remains elevated as investors attempt to balance easing supply fears against the risk that inflationary pressures could become more persistent. The result is an environment characterised by fluctuating risk sentiment, higher bond yields, cautious central banks and significant sector divergence across global markets.
U.S.
The US economy continues to display surprising resilience, though it faces renewed domestic headwinds. The annual inflation rate in the US accelerated to 3.8% in April, the highest since May 2023, and compared to 3.3% in March, with energy contributing meaningfully to the increase. In response, the Federal Reserve left interest rates unchanged, reinforcing a “higher-for-longer” policy path that has defied early-year rate-cut expectations.
Consequently, the 10-year US Treasury yield has been highly volatile, oscillating between 4.2% and 4.7%. Recent optimism surrounding ceasefire negotiations has provided some relief, allowing yields to retreat modestly from their highs, but bond market volatility remains significant. The dollar remained firm on the back of relatively higher US yields and safe-haven demand, although it softened in brief windows when oil prices retreated on growing optimism for a lasting ceasefire deal.
Economic activity indicators have softened but remain in expansionary territory. Manufacturing PMIs have shown signs of slowing amid rising input costs, while consumer spending has remained underpinned by a tight labour market.
Equity markets recovered substantially from their March lows, led by technology and artificial intelligence-related sectors, with the S&P 500 and Nasdaq pushing to new record highs. The Q1 earnings season proved exceptionally strong, boasting year-on-year earnings growth exceeding 28%. Semiconductor companies and tech giants were among the standout performers as AI-related capital expenditure remained robust despite macroeconomic uncertainty.
United Kingdom
The UK continues to face a difficult combination of slowing growth and elevated inflation. April inflation slowed to 2.8%, yet the conflict kept fuel inflation elevated. Labour-market data showed rising unemployment and softer wage growth, signalled weakening domestic demand, even as sticky services inflation forced the Bank of England (BoE) to maintain a restrictive stance.
UK Gilts closely mirrored the volatility of US Treasuries. The 10-year Gilt yield remains elevated as markets price in prolonged tightening to combat wage-price spirals.
The UK Composite PMI exposed a clear divergence. Manufacturing slipped into a slight contraction as firms reported falling output, supply shortages, and job cuts linked to the conflict-driven cost shock, while the services sector remained relatively resilient.
The FTSE 100, heavy on energy and mining stocks, saw a pullback as oil prices dropped 20%, causing it to underperform its European peers. Q1 corporate earnings have been mixed: commodity‑linked firms and global exporters have generally fared better than purely domestic cyclicals.
Europe
The Eurozone remains highly exposed to the conflict’s geopolitical fallout, given its structural reliance on imported energy.
Inflation accelerated sharply over the spring, trending back towards 3%, significantly above the European Central Bank’s (ECB) target. These renewed inflationary pressures have complicated the ECB’s policy roadmap and prompted increasingly hawkish commentary from policymakers who had previously hinted at aggressive easing. Sovereign bond yields fluctuated heavily based on weekly oil headlines. The Euro strengthened modestly as markets increasingly priced the possibility of a more restrictive ECB stance.
Flash PMI data points to a sluggish growth environment. Manufacturing activity remains subdued, reflecting both high energy costs and softer global demand, while services activity provided some support to overall economic growth.
European equities underperformed the US but held up better than expected, buoyed by a rotation into defensives and select industrial and defence names. The pan-European STOXX 600 index recovered losses as peace prospects improved with strong Q1 earnings in luxury goods, industrials tied to AI and automation and select financials.
China
China has experienced the conflict’s ripples primarily through commodity prices, trade channels, and shifts in global risk sentiment rather than direct financial exposure. Higher energy and materials prices have raised input costs for the Chinese industry, affecting manufacturing activity and trade flows. PMI data showed factory activity still expanding, though with caution around new orders and margins.
Inflation has remained relatively subdued compared to advanced economies, allowing the PBoC to ease policy further. The government has continued to support growth through targeted stimulus measures and efforts to strengthen domestic consumption. However, ongoing weakness in the property sector and cautious household spending continue to limit the pace of recovery.
Chinese equities underperformed many developed markets, although green technologies and advanced manufacturing sectors have shown relative resilience. The Renminbi (RNB) has remained broadly stable, managed by tight policy interventions and improving trade relationships with key partners. From an industrial perspective, the retreat in oil prices acts as a major net positive for China’s massive refining and petrochemical sectors.
Japan
As a major net energy importer, Japan has seen its trade deficit widen over the last three months. The Bank of Japan (BoJ) has shown greater tolerance for higher headline inflation, viewing this energy‑driven rise as an opportunity to entrench inflation around its 2% target and move away from historic negative interest rate regimes.
The yen weakened when US yields rose, and the Japanese government bond yields moved up, reflecting both interest-rate differentials and domestic concern about energy-import costs.
PMI data show that Japanese manufacturing has come under pressure by higher import costs and softer external demand, while services have benefited from a recovery in tourism and domestic reopening dynamics. Equity markets have performed strongly, driven by ongoing corporate governance reforms, share buybacks, and renewed foreign investor interest, even as higher energy costs have weighed on some industrials. Q1 earnings have generally been solid, particularly for large-scale exporters benefitting from a weaker yen.
Commodities
The conflict has kept crude, gas, freight, insurance, and refined products at elevated levels, even after the latest 20% pullback on hopes that a favourable deal is imminent. Oil remains the primary transmission channel into inflation, but the ripple effects have extended to industrial metals, fertilisers, and food supply chains through higher transport and input costs.
Fertiliser prices have surged, raising concerns about future crop yields and food security, while key industrial metals such as copper and aluminium have hit or approached record highs, driven by both supply disruptions and strong structural demand from data centres, EVs, and renewable energy.
Precious metals, especially gold have continued to attract safe-haven demand and diversification flows, amid ongoing geopolitical uncertainty and bond market volatility.
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Disclaimer
The views and opinions expressed should not be construed as investment or financial advice. The information contained is for educational purposes only.