Written by Israel-Iran clash continues
After nearly 3.5 months of tariff-driven markets, with US President Trump’s shenanigans producing a plethora of risk-off episodes, investors seem to have bigger fish to fry now. They are anxiously watching developments in the Middle East, where Friday’s initial Israeli operation on Iranian soil has triggered a tit-for-tat situation, like a boxing match, with both nations now exchanging missile attacks on a daily basis.
These types of skirmishes have become more frequent since the October 2023 events, when a Hamas-led attack on Israel set off the ongoing conflict in Gaza. Usually, there is a brief cycle of back-and-forth between Israel and Iran – including Iran’s proxies – before the West intervenes, with the situation quieting down for a while. Should this be repeated this time as well, market reaction could follow a familiar historical pattern.
However, there is a feeling that the situation might evolve differently this time around. Rhetoric from Israeli officials and the targeting of Iran’s oil and gas infrastructure and facilities – the world’s largest natural gas field, oil refineries, and fuel depots have already been hit – could be seen as an Israeli attempt for a regime change in Iran.
Meanwhile, European leaders are pushing for a ceasefire, but it might be too early for both Israel and Iran to discuss such an option. Interestingly, there is a G7 meeting taking place in Canada on June 15-17. There will probably be extensive talks about the Middle East events and tariffs. Notably, markets still remember the famous “Trump vs. everyone” photograph from the 2018 summit.
Initial risk-off reaction fades
Given the dollar’s newly found risk-on behaviour, the greenback got an unexpected boost on Friday, outperforming the remaining key currencies. These gains were not enough, though, to reverse the dollar's earlier weak performance, with euro/dollar closing the week up 1.4%, followed by a 1.3% selloff in dollar/Swiss franc.
Friday's risk-off sentiment was also quite evident in equities, with US stock indices experiencing their weakest daily session since May 21, when a disappointing 20-year US Treasury auction pushed yields higher, adding to concerns that Trump's proposed budget bill might fail to address the ballooning US debt. Notably, US equity indices managed to outperform their European counterparts last week, as the DAX 40 index suffered its deepest losses since the first week of April.
On the flip side, both gold and oil jumped on news of escalating tensions in the Middle East, with the latter quickly climbing and reaching a fresh five-month high.
Risk appetite appears to be improving slightly today, with the dollar losing a bit of ground, both oil and gold surrendering a decent portion of their recent gains, and bitcoin climbing to the $106k area again. However, this risk-on reaction could quickly reverse, especially if Iran openly threatens to block the Hormuz Straits.
Central bankers face another hurdle
These developments have come amidst one of the most important weeks in 2025. Four central banks will hold their rate-setting meetings this week, with the BoJ kicking things off on Tuesday and the Fed announcing its decision on Wednesday. The FOMC’s position up to now has been to wait for the tariff dust to settle before making monetary policy decisions. However, the Fed’s job has just become even harder, as the Middle East events could unsettle the rates outlook, creating a real inflation headache if oil prices keep rising.
By XM.com
