Two months after the outbreak of the Middle East crisis, Capital Economics released an asset allocation update that focuses on three core questions about how markets have absorbed the shock and what may lie ahead.
The note, led by Thomas Mathews, head of markets in Asia Pacific for Capital Economics, opens with a puzzle: why have equity benchmarks largely recovered when oil is still around 50% higher than before the conflict began and the MSCI All Country World Index sits slightly above its pre-conflict level?
Mathews contends that headline indices mask important dispersion beneath the surface. In the firm's view, the apparent recovery owes much to a renewed appetite for technology stocks. As he writes, "renewed enthusiasm for 'tech' stocks has provided a big, but patchy, offsetting boost," leaving many other sectors and less tech-heavy regional indices still trading below where they stood before the conflict.
Capital Economics cautions that the current lifting of equity indices could be fragile. The firm says that if mounting evidence shows the conflict is denting corporate earnings, "equities could in principle fall a lot further than they had even at their weakest point last month." Under an adverse scenario, Capital Economics sketches an S&P 500 year-end target of around 6,000.
The firm's second focal point is the bond market. Capital Economics sees a more permanent change to the interest-rate outlook following the conflict, and it doubts the Federal Reserve or the Bank of England will cut policy rates this year. In its assessment, the war has had a durable effect on the monetary policy outlook, implying that yields and central bank plans may remain less accommodative than markets previously expected.
The third question centers on currency performance, specifically why the U.S. dollar has remained resilient against both commodity currencies and traditional safe havens. Capital Economics notes that the Swiss franc and Japanese yen have been among the worst-performing currencies during the conflict, a pattern it links in part to both countries' status as net energy importers and to relative yield movements that have gone against them.
Despite recent weakness, the firm emphasizes that the safe-haven credentials of both the Swiss franc and the Japanese yen remain structurally intact.
Taken together, the update highlights an uneven market response: major equity indices can look deceptively stable while internal sector and regional divergences persist; bond markets may have repriced the probability of rate cuts; and currencies have reflected both energy dependence and yield dynamics even as long-run safe-haven roles endure.
For investors, the note signals that headline stability should not be mistaken for broad-based market health and that further evidence on earnings, inflation, and central bank reactions will be decisive for how these three market questions are ultimately resolved.