Markets hold their nerve as geopolitical risks build

Market overview

Global markets continue to balance escalating geopolitical tensions against unusually subdued currency volatility. Further US strikes on Iranian targets and growing concerns around regional energy infrastructure have supported oil prices, short-dated yields and the dollar, yet FX markets remain hesitant to price a sustained risk-off move.

The dollar would typically benefit more strongly from higher energy costs, softer equities and increased uncertainty. However, compressed volatility continues to favour carry trades, while last week’s weaker US CPI and PPI readings reduced some of the Federal Reserve tightening premium that supported the dollar through June.

The key question is whether disruption spreads across major shipping routes. Continued pressure around the Strait of Hormuz, alongside the threat of Houthi activity near the Bab el-Mandeb, could materially tighten global energy supply and disrupt alternative export routes. A prolonged shock would favour the US relative to major energy importers, particularly across Asia and Europe.

USD: Energy risks maintain support

The broader dollar outlook remains constructive. Higher oil prices, geopolitical uncertainty and the US position as a net energy exporter continue to strengthen its relative growth and terms-of-trade advantage.

Safe-haven demand has so far been restrained, but the dollar should remain supported while energy risks persist. A more decisive move higher may require either a sustained rise in FX volatility or clearer evidence that the conflict is creating a lasting disruption to global supply.

GBP: Fiscal credibility moves into focus

Sterling was largely unchanged following Andy Burnham’s appointment as the UK’s seventh prime minister in a decade, with the political transition already well priced.

Burnham used his opening speech to prioritise cost-of-living support while stressing that new measures would remain consistent with the government’s fiscal rules and defence commitments. His promise of a new economic model and the most significant reforms in 40 years will eventually face closer market scrutiny, particularly ahead of the 2026 Autumn Budget.

Investor sensitivity to the UK’s fiscal position remains high. Gilts sold off sharply after Burnham suggested that available fiscal headroom could help fund his programme, pushing the 10-year yield above 5%.

The appointment of John Hailey as Chancellor also raises questions around future spending. His support for increasing defence expenditure to 3% of GDP by 2030 could add further pressure to the public finances, even though the initial market reaction was limited.

This morning’s labour market data offered some encouragement. Unemployment remained at 4.9%, while three-month employment growth reached 148,000, comfortably above the 80,000 forecast. Wage growth slowed to 4.3%, below expectations of 4.5%, but remained above the levels recorded earlier in the year.

The figures point to a labour market that remains soft but is beginning to stabilise. This may ease the Bank of England’s policy dilemma between weakening employment conditions and persistent inflation pressures.

EUR: Rate support meets weaker growth

The euro continues to face conflicting drivers. Softer US inflation has reduced expectations for further Federal Reserve tightening, while rising energy-related inflation risks have prompted a modest increase in ECB rate expectations.

This has provided some near-term support to the euro, but the backdrop remains fragile. Higher energy costs weaken the eurozone’s terms of trade and threaten growth, meaning any ECB tightening driven by imported inflation may offer only limited currency support.

Today’s ZEW sentiment surveys will provide an important indication of whether the eurozone economy is stabilising. Last month’s release helped EUR/USD recover from one-year lows, but renewed geopolitical uncertainty leaves the risks tilted towards a weaker reading.

EUR/USD remains supported near 1.1400, with resistance around 1.1450 to 1.1470. Without an improvement in energy conditions or regional growth expectations, the wider outlook remains cautiously bearish.

Looking ahead

• Eurozone ZEW sentiment surveys will test confidence in the region’s economic recovery.

• UK inflation data for June is due tomorrow and will be central to the Bank of England outlook.

• Markets will monitor policy announcements from the new UK government, particularly any spending commitments.

• Oil prices and developments around the Strait of Hormuz and Bab el-Mandeb remain the main global risk drivers.

• A sustained rise in FX volatility could accelerate safe-haven demand for the dollar.