Markets look beyond headlines as US–Iran tensions ease

Why the worst-case scenario was never fully priced in

Over the past three months, headlines have been dominated by conflict in the Middle East, soaring oil prices, threats to global shipping routes, and warnings of a renewed inflation shock. Many analysts laid out the prospect of oil surging to US$150 a barrel (if not higher), inflation accelerating, and central banks being forced to keep interest rates higher for longer - or even resume tightening.

Yet despite the noise, equity markets (bond markets have been a slightly different story) never fully bought into the worst-case scenario. The preliminary deal has validated the optimism that was already embedded in stock markets.

Markets are often accused of being irrational. Yet during the past three months they may have shown considerably more discipline than many commentators. While headlines focused on worst-case scenarios, equity markets quietly concluded that the economic damage was likely to be temporary.

The S&P 500 in the US has remained close to record highs throughout much of the period, while many global markets finished the conflict not far from where they started. Volatility proved relatively short-lived. Investors appeared increasingly willing to look through the headlines.

What is striking is not that markets have rallied on signs of de-escalation. What is striking is that they never fell very far in the first place.

Investors appeared to view the conflict as a temporary disruption rather than a lasting economic shock. While news coverage focused on military developments and geopolitical tensions, markets spent much of the past three months trying to determine whether the conflict would evolve into a genuine economic shock.

Increasingly, the answer appears to be no.

AI, earnings and long-term growth remain key drivers

Oil prices have fallen sharply from their recent highs, bond yields have eased, and equity markets have continued higher as investors increasingly price in a de-escalation of the conflict.

It is also worth remembering that geopolitics is only one of the forces driving markets. In many respects, the conflict was competing for investor attention with another far larger story: artificial intelligence. While headlines focused on the Middle East, investors were also weighing strong earnings growth from technology companies and hundreds of billions of dollars of planned investment in AI infrastructure. For many, those long-term opportunities remained more important than a potentially temporary spike in oil prices.

That should perhaps not come as a complete surprise. One of the key questions throughout the conflict was whether it would lead to a sustained disruption in global energy supplies. As we wrote in this column at the start of March, if that did not occur, the long-term drivers of markets - corporate earnings, technological innovation, productivity growth and monetary policy (albeit connected to rising oil prices) - were always likely to matter more than the geopolitical headlines dominating news coverage.

Had the conflict led to a prolonged disruption of energy supplies, the story would have been very different. Inflation pressures would almost certainly have remained elevated, forcing central banks to keep interest rates higher for longer and potentially altering the path of monetary policy altogether. The key question was whether a prolonged energy shock would materialise.

Short-term volatility often reflects investors pricing in a range of potential outcomes, including worst-case scenarios. The critical question is whether those scenarios ultimately materialise.

Markets weren’t ignoring the conflict. They were assigning a lower probability to the worst-case scenario than the headlines suggested. So far, that judgement appears to have been correct.

This is not the first time markets have responded this way. Over recent years investors have repeatedly confronted events that initially appeared capable of derailing markets: wars, tariff disputes, banking crises, political upheaval and energy shocks.

Part of the reason markets appear more resilient is that investors have become conditioned by experience. Time and again, periods of escalation have ultimately given way to negotiation, while worst-case scenarios have failed to materialise.

As a result, markets increasingly seem less interested in the headlines themselves and more interested in whether those events ultimately affect inflation, economic growth and company earnings. If the economic consequences appear manageable, investors are becoming increasingly willing to move on.

That does not mean markets will always be right. Eventually there will be events that prove more serious than investors anticipate. But it helps explain why investors have become increasingly reluctant to sell first and ask questions later.

Those who repeatedly reacted to every headline over recent years have often found themselves wrong-footed as markets recovered faster than expected.

Falling oil prices ease inflation and interest rate pressure

For investors, the issue was never really the conflict itself. It was the inflationary consequences of higher oil prices and disrupted supply chains.

The timing of the deal announcement is therefore highly significant.

This week brings a heavy schedule of central bank meetings, with the Federal Reserve firmly in focus alongside the Bank of England.

Only a short time ago policymakers were grappling with the possibility that higher energy prices might not only delay rate cuts, but potentially force a return to tighter monetary policy.

The recent decline in oil prices may allow central banks to focus once again on economic growth rather than inflation. For the Federal Reserve, the key question is whether policymakers view the recent inflation pulse as temporary and energy-driven. This week’s meeting will also be closely watched as the first under Chair Kevin Warsh, with investors looking for clues as to whether he may prove more supportive of lower interest rates if inflation eases.

While recent developments are encouraging, it is important not to overstate the shift.

Bond markets continue to reflect a more cautious underlying reality.

While equity investors have focused on resilient earnings and the prospect of eventual policy easing, bond investors remain wary that inflation could prove more persistent than many expect.

Ironically, investors may soon discover that the bigger threat to lower interest rates is not a shipping lane in the Middle East, but government balance sheets. While oil prices have dominated headlines, bond markets continue to signal concern about large fiscal deficits, rising debt levels and growing interest costs across developed economies. Those pressures are likely to outlast the current conflict.

Even if energy prices continue to fall, that longer-term challenge has not disappeared.

What this means for New Zealand borrowers and KiwiSaver investors

While markets have largely focused on the economic consequences of the conflict rather than the conflict itself, New Zealand borrowers have had something much more tangible at stake.

Rising oil prices had begun pushing up inflation expectations globally and, in turn, wholesale interest rates. Markets increasingly questioned whether central banks would be able to continue easing policy. For a country still trying to emerge from a difficult economic period, that was becoming a significant concern.

This matters because New Zealand is arguably one of the most interest-rate-sensitive economies in the developed world. Changes in wholesale interest rates tend to flow relatively quickly through to mortgage holders, business borrowers and asset prices.

This week’s GDP figures will provide a snapshot of how the New Zealand economy was performing before the conflict intensified. Markets, however, are less interested in where the economy was three months ago than where it is heading next.

If the current framework evolves into a lasting peace agreement, it would reinforce the view that local banks and some economists may have moved ahead of themselves in pricing a more hawkish interest-rate outlook. As Reserve Bank Governor Anna Breman has suggested, policymakers were prepared to “look through” temporary, conflict-driven increases in oil prices.

If oil prices continue to retreat and inflation concerns ease, pressure on wholesale borrowing rates could also begin to reverse. Just as importantly, it reduces the risk that borrowers face another round of higher interest rates, providing some welcome certainty after months of concern that central banks might need to keep policy tighter for longer.

Fuel prices are already beginning to respond. Diesel prices have fallen sharply from their recent peaks, while petrol prices are also moving lower. For households and businesses that have spent months grappling with rising transport and operating costs, that relief will be welcome.

More broadly, a sustained easing in energy costs would improve confidence, support consumer spending and reduce pressure on business margins. Rather than a difficult second half of the year, there is a plausible scenario where New Zealand’s economy regains momentum as lower fuel costs, easing inflation pressures and eventually lower borrowing costs create a more supportive backdrop.

The long-term lesson: discipline over headlines

Over the past three months, the news cycle suggested the world was becoming a more dangerous place. Markets, however, spent much of that time believing that cooler heads would eventually prevail.

So far, they appear to have been right.

Markets are increasingly focused on the economic consequences of geopolitical events rather than the headlines surrounding them, while balancing those risks against other powerful forces shaping the global economy, including artificial intelligence, corporate earnings and the path of interest rates.

For investors and KiwiSaver members, the episode is another reminder that markets typically begin looking ahead long before the news improves. By the time uncertainty disappears from the headlines, much of the recovery is often already reflected in asset prices.

For borrowers and investors alike, that distinction may prove far more important than the headlines that dominated the news.

Keeping a cool head is not complacency. It is discipline.