Market overview

Markets are moving into a more fragile phase. The Trump and Xi meeting offered little more than political theatre, while Iran-related risks remain unresolved and oil continues to grind higher. At the same time, long-end yields in the US, UK and Japan have all broken higher, challenging ranges that had held for months, and in some cases years.

Equities have so far leaned on strong earnings, but that support is becoming less powerful as reporting season fades. The market narrative is now shifting back towards inflation, real yields and financial conditions. That matters because higher yields are rarely a problem until they begin to damage the earnings story investors are using to justify valuations.

The risk is not simply that rates are higher. It is that rising energy prices, firmer inflation expectations and tighter real yields start to hit consumers and corporate margins at the same time. For now, markets are still functioning, but the balance of risks is becoming less forgiving.

USD: Defensive appeal may return

The dollar has yet to fully respond to the rise in US yields. Strong risk appetite and higher yields elsewhere have diluted the usual rate advantage, keeping the move contained.

That may not last. If equities lose momentum as earnings support fades, the dollar’s defensive profile should become more valuable. Forward rates are already pointing to a more persistent inflation backdrop, particularly beyond the immediate policy horizon.

A commodity-led inflation impulse tends to be uneven and disruptive, which usually favours dollar demand when volatility rises. The current gap between firmer US yields and a broadly rangebound dollar looks increasingly vulnerable.

GBP: Politics eases, but risks remain

Sterling recovered on Monday, outperforming major peers despite a broader bond sell-off. The move looked UK-specific, helped by a partial reversal of the political risk premium linked to a potential Andy Burnham leadership challenge.

Last week’s concerns were centred on the prospect of looser fiscal policy and higher borrowing, which had unsettled gilt markets and pulled GBP/USD sharply lower. Those fears eased after Burnham signalled he would respect existing fiscal rules, helping gilts stabilise and sterling recover ground.

GBP/USD is back above 1.34, while GBP/EUR has regained the 1.15 area. Both have moved tentatively above their 200-day moving averages. Even so, UK political uncertainty is not over. A leadership contest through the summer would keep investors cautious on UK assets.

The Bank of England also remains boxed in. Labour demand is cooling, with unemployment at 5% and payrolls falling, but wage growth remains sticky. Inflation data will now be key, though markets may need a clear downside surprise to rethink the relatively tight BoE path.

EUR: Energy sensitivity keeps the downside exposed

The euro’s rebound looks more like a technical reset than a genuine shift in sentiment. EUR/USD had fallen heavily for four straight sessions, and hopes of a near-term US-Iran deal briefly helped the pair recover. Those hopes faded as fresh proposals failed to deliver a breakthrough.

Energy remains the euro’s key vulnerability. The eurozone’s reliance on imported energy means headlines around the Strait of Hormuz are likely to keep driving short-term price action. Investors are also watching whether China takes a more active role in trying to move negotiations forward.

Friday’s bond sell-off underlined the issue. Higher global yields might normally support fixed income demand, but the euro’s negative reaction showed limited appetite for European exposure while the region’s macro outlook remains clouded. With the 2022 energy shock still fresh in memory, higher European yields alone may not be enough to attract sustained inflows.

EUR/USD appears to be holding near the 1.16 lows for now, but the balance of risks remains skewed lower unless there is a credible de-escalation.

Looking ahead

• Watch oil and Strait of Hormuz headlines as the main drivers of inflation risk and euro sensitivity.
• US forward rates and real yields remain central to the dollar outlook.
• Equity resilience will be tested as earnings support fades and macro takes over.
• UK inflation data will shape BoE expectations, but the hurdle for a dovish repricing remains high.
• EUR/USD risks another test of 1.16 without meaningful progress on de-escalation.