Asian equity markets ended the week lower on Friday, capping a turbulent stretch that has left regional shares on track for their sharpest weekly declines in years as fighting in the Middle East failed to show signs of rapid de-escalation.
Investor behavior reflected a turn toward safety and a recognition that the U.S.-Israel conflict with Iran may be more protracted than initially thought. That shift has coincided with a reassessment of interest-rate prospects at major central banks, with markets pricing in a more hawkish outlook amid the risk that an energy-driven jump in inflation could be sustained.
U.S. Treasury yields moved markedly higher over the week, rising roughly 18 basis points - their largest weekly increase in nearly a year - while the dollar posted its biggest weekly advance in 16 months. Those moves amplified pressure on risk assets and influenced cross-asset flows across the globe.
"The range of plausible outcomes (of the war) has expanded to include both the possibility of an exceptionally constructive resolution and a highly destructive one," said Daleep Singh, chief global economist at PGIM Fixed Income. "Markets are being asked to price a much fatter set of tails with very little reliable information about the likelihood of each, or the path in between."
Energy prices have been the clearest market signal of the geopolitical shock. Brent crude futures were trading around $83 per barrel after having been as low as $69 about a week earlier. U.S. crude touched a 20-month high earlier in the week. Both benchmarks were set to record rises exceeding 15% for the week, the largest weekly gains since February 2022.
"The most market-relevant risk lies in severe escalation or direct infrastructure damage across key Gulf producers, which would likely produce sustained upward pressure on oil, feed into higher headline inflation, tighten global liquidity, and materially raise recession risks," said Klay Group's senior investment team.
Not all stock markets moved in concert, but the direction was broadly down. MSCI's broadest index of Asia-Pacific shares outside Japan last traded 0.4% lower and was set for a weekly drop of 6.6%, which would be its steepest weekly decline since March 2020. Japan's Nikkei fell 0.5% on the day and was headed for a 6.5% weekly loss, while South Korea's Kospi was pacing toward a 10.5% slide for the week, a six-year low.
The market rout extended into previously high-flying pockets of technology and other growth-linked areas as investors scrambled to realize gains and bolster liquidity for losses in other positions. Funding conditions tightened amid a stronger dollar and higher U.S. yields, putting pressure on levered exposure.
"When the dollar rallies and U.S. yields rise, funding conditions are tightening, which will often exacerbate broader moves particularly if there's leverage involved," said Ben Bennett, head of Asia investment strategy at L&G Asset Management.
In contrast to the weakness in spot equity markets, U.S. stock futures were steady in Asian trading on Friday, while European futures showed modest gains - EUROSTOXX 50 futures rose 0.6% and DAX futures added 0.5%.
The dollar emerged as one of the week's few broad winners, bolstered by safe-haven demand and a scaling back of rate-easing expectations for the United States. Although the greenback's rally paused on Friday, it remained on track for a weekly gain of about 1.4%.
Major currencies weakened against that backdrop. The euro was set to fall 1.7% on the week and sterling was heading for a 0.95% weekly decline. Market participants reduced expectations for near-term policy easing: investors are pricing in roughly 40 basis points of Fed easing this year, down from 56 basis points a week earlier. The probability of a Bank of England rate cut this month fell sharply to 23% from what had been seen as near certainty the prior week. In contrast, markets expect the European Central Bank to be in a position to hike rates by year-end.
Higher rate expectations fed back into global bond markets. In Asia on Friday, the 10-year U.S. Treasury yield was steady at 4.1421%, having climbed about 18 basis points over the week. The two-year U.S. yield rose roughly 20 basis points across the same period.
Gold's safe-haven appeal was undercut by higher yields and the stronger dollar. Spot gold was steady at $5,078.88 an ounce on Friday but was on track for a 3.7% weekly decline.
With markets recalibrating to the twin risks of elevated energy prices and tighter financial conditions, the coming days will likely continue to test asset prices until there is greater clarity on the trajectory of the conflict and its impact on supply, inflation and policy expectations.