Another tumultuous week lies ahead with focus squarely on the Middle East and energy prices, amid a relatively quiet data calendar. Investors need to digest the hawkish pivots by multiple major central banks, with bond markets pricing in multiple rate hikes by the Bank of England and ECB for 2026. The FOMC is now also seen potentially tightening policy by December, as the prolonged conflict in the Middle East sees inflation risks now too strong for policymakers to ignore.
At the start of the conflict, it was generally thought that rate setters would be able to use the textbook reaction to an energy price spike and “look through” the Iran shock, as growth would be negatively affected and central banks would not need to pull the trigger on raising policy rates. Indeed, a recent strategy review (by the ECB) acknowledged that the flexibility in the medium-term inflation target should allow larger short-term deviations due to more frequent supply shocks.
But it seems the ‘scars’ from 2022 and the now forbidden ‘t-word’ (“transitory) have lowered the bar for policy action, helping central bankers’ firm up they inflation-fighting credibility. History tells us they tend to fight their last wars – see the GFC in 2008 and overly hawkish action or 2022 and overly dovish deeds. All that said, ultimately, the higher energy prices and interest rate expectations go, the greater the risk something breaks. Indeed, the BoE last week talked about rate cuts as well as hikes, if the labour market gets hits.
Stock markets look weak technically though they did close off their lows last week. The Dow Jones and Nasdaq are close to falling 10% from record highs, so technical corrections are in play. We’ve haven’t had more than four weeks of straight selling in nearly four years on the Dow. The German Dax is faring even worse and is back to levels last seen just after Liberation Day in late April. Gold posted its worst week since 1983 (-9%) as the haven trade broke down under the weight of a strong dollar and a Fed that told the market it cannot cut rates into an oil shock. Next major support is around $4,400 with the 200-day SMA below at $4,066. Will a big tumble in equities see the Trump put / “TACO” return? Late Friday saw a gesture by the POTUS, but its seems like there is a new phase of escalation, judging from headlines over the weekend.