Middle East tensions ease briefly, but uncertainty persists as markets weigh U.S. midterm impact and potential Iran deal collapse amid energy concerns.
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Welcome to the latest edition of The Weekly Fix. My name is Andrzej Skiba.
While the armed conflict in the Middle East continues unabated, markets have recovered some of the losses of late based on hopes of a near-term de-escalation. With the midterms coming and a Republican control of the Senate under question for the first time in a long while, we see a decent chance of a positive resolution on the horizon. Having said that, it remains unclear whether the Iranian side is willing to make a deal on the terms proposed by the U.S., especially considering the leverage it holds over the strategically important Strait of Hormuz. The situation remains fluid and there is a clear risk that hopes for a quick deal could well be dashed.
If the conflict ends soon, while we expect U.S. growth projections to be negatively impacted, we see a low likelihood of a major slowdown hitting the U.S. economy. A longer stand-off could have more serious implications, however even in that case, we see a modest risk of a US recession, given that U.S. is energy self-sufficient and it’s a pretty closed economy. The same cannot be said for European and some Asian countries where the risk of recession is looming larger.
With no rate cuts priced for the remainder of the year, we feel it’s unlikely we will witness major underperformance of Treasuries going forward. In our opinion, the bar for rate hikes is higher than many think given the Fed’s dual mandate and upcoming leadership changes. This is less clear regarding assets such as German government bonds, where the ECB has a solely inflation-driven mandate and the continent is experiencing an energy price shock as we speak.
Credit has been trading as a side-show to geopolitical events and spread widening has been modest so far. When fears of ground troop deployment were circulating a week or so ago, we’ve seen some evidence of increased risk aversion and spread de-compression leading to the underperformance of higher beta assets, however this was relatively short-lived. High quality, defensive US bonds remain in strong demand as yield-sensitive buyers are taking advantage of a sell-off in Treasury yields to lock in attractive entry points. Across our portfolios, we favor U.S. assets and stay away from deep cyclicals.
In summary, while uncertainty remains high, we maintain a modest overweight bias. This is driven by what we see as historically attractive yields of fixed income assets and a strong, possibly double-digit forward 12-month total return potential, were this crisis to abate. Since downside risks are material, we stay away from growth-sensitive issuers, apply conservative credit selection and, where appropriate, use portfolio hedges to shield our strategies. We stand ready to forcefully adjust our exposures were this to be needed over the weeks to come.
Thank you for your attention.
Key points
Markets rebound on de-escalation hopes – Recovery driven by potential U.S. midterm outcomes and possible Iran negotiations, though deal remains uncertain given Iran's strategic leverage over Strait of Hormuz.
Regional recession risks diverge – U.S. economy appears insulated due to energy self-sufficiency, while European and Asian markets face heightened recession risk from energy price shocks and greater economic exposure.
Defensive positioning favors quality – Portfolio strategy emphasizes U.S. high-quality bonds over deep cyclicals, maintains modest overweight with conservative credit selection and hedges to pursue attractive yields while managing downside risks.