Market's premature optimism. Justified or not?

The current dynamics of financial markets are increasingly diverging from classical fundamental models and becoming more dependent on expectations. Donald Trump's recent statements about possible rapid progress in geopolitical negotiations have created a market sentiment of an approaching positive resolution. This sentiment, rather than actual changes in macroeconomic conditions, has become the primary driver of asset movements.

Markets are already behaving as if the de-escalation scenario is the baseline. Stock indices have not only recovered losses but have also exceeded pre-war levels, which is an atypical reaction to such geopolitical shocks. Against this backdrop, the dollar, traditionally acting as a safe-haven asset, has begun to lose ground. This decline is not merely a short-term reaction to improved sentiment — it reflects a deeper problem.

The most important signal is that the dollar failed to demonstrate convincing growth even in the initial phase of the conflict when uncertainty was at its peak. In a classical macro environment, it is precisely during such periods that the strongest demand for safe-haven assets typically forms. The absence of this demand indicates that the fundamental basis of the dollar was already weakened even before the events began.

This weakness becomes more apparent when analyzing capital flows. Foreign investor demand for US government bonds is gradually declining, as evidenced by both market data and the fall in the volume of assets held in Fed accounts for foreign participants. In a broader context, this means that the mechanism that supported the structural demand for the dollar for years — namely, the recycling of global liquidity back into the US — is beginning to falter.

The energy sector plays an especially important role in this process. Reduced revenues from energy sales mean smaller dollar flows, which are traditionally reinvested in US assets. If this trend continues, it will create additional pressure on the dollar in the medium term.

At the same time, macroeconomic data in the US also offer no grounds for a dollar rebound. Recent inflation figures show signs of softening, prompting the market to revise expectations regarding further actions by the Federal Reserve. A scenario is forming in which monetary policy gradually shifts from tight to more neutral or even accommodative. This, in turn, reduces the dollar's attractiveness as a store of value.

Against this background, the behavior of the oil market is particularly indicative. Despite the scale of the geopolitical shock, oil prices have not shown sufficiently strong growth to cause concern about a global economic slowdown. In real terms, they remain significantly below previous peaks, allowing the market to maintain stability and support risk assets.

It is precisely the absence of a full-blown energy shock that explains why a shift to a classic risk-off scenario did not occur. Investors do not see an immediate threat to global growth and therefore have no incentive to sharply reduce risky positions. However, this balance is unstable. In the event of further increases in energy prices, inflationary pressure could intensify, leading to a change in the structure of the US yield curve. Historically, such changes are often accompanied by a weakening dollar.

In the foreign exchange market, this is reflected in the atypical behavior of major pairs. EUR/USD, for example, has effectively returned to levels observed before the conflict began. This appears unusual given the scale of the risks and indicates a high degree of confidence in a positive scenario of events.

This dynamic is partly explained by the relative stability of the European economy and the cautious rhetoric of Christine Lagarde, who does not signal the need for immediate aggressive actions by the ECB. The market continues to price in gradual rate hikes, which supports the euro. However, this support is conditional and largely depends on the maintenance of the current level of optimism.

The pound, in turn, appears weaker due to the Bank of England's more restrained stance. Andrew Bailey emphasizes the need for a cautious approach, which lowers expectations for further rate hikes and limits the British currency's growth potential.