Do the Markets No Longer Know What to Expect?
Prices in the financial markets are largely driven by investors’ expectations about the future. While the future is always difficult to predict, what should we infer from the fact that the S&P 500 index, the U.S. dollar exchange rate, and long-term interest rates have been moving sideways within relatively narrow ranges for some time?
Some technical analysts argue that this is nothing unusual and merely represents a consolidation within the prevailing trend. In the case of the S&P 500, that trend is upward; for the dollar, it is downward. Accordingly, these analysts expect equities to begin rising toward new highs in the near term and anticipate that the euro/dollar exchange rate will soon move above 1.20.
It should be noted, however, that other technical analysts interpret the recent price action in the S&P 500 and the euro/dollar pair as a potential “rounding top,” suggesting that a decline may follow in due course. For now, this view remains a minority position.
Our own assessment lies somewhere in between. Investor sentiment has recently been marked by considerable uncertainty about the outlook, which is reflected in markets that appear reluctant to commit to a clear direction. In our view, this uncertainty stems primarily from the following factors:
Risk of War in the Middle East?
The United States has assembled a substantial naval presence off the coast of Iran as leverage to pressure the Iranian regime into reaching an agreement on its nuclear program and facilities. It is widely assumed that this show of force will compel the current Iranian government to concede, given Iran’s relatively limited military capacity compared to the U.S.
However, some experts disagree. They argue that, ultimately, a military conflict could be more advantageous for the current Iranian regime than capitulating to U.S. demands. In that respect, recent developments lend some support to this perspective: negotiations have yielded limited progress, and the U.S. appears increasingly prepared for a potential military strike on Iran.
A conflict, therefore, cannot be ruled out. Moreover, it could easily spread across the broader Middle East, with potentially significant consequences for global oil prices.
Is AI Ultimately Positive or Negative?
Equity markets have experienced a prolonged period of rapidly growing enthusiasm around artificial intelligence (AI). The prevailing expectation is that substantial investment in AI will soon translate into a sharp increase in productivity. This could lead to declining labor costs and lower inflation, enabling central banks to reduce interest rates. In other words, such a scenario would combine strong economic growth with low inflation and low interest rates—an ideal environment for equity markets.
However, many experts consider this outlook overly optimistic. They expect productivity gains to materialize only gradually and on a more limited scale across the broader economy. In that case, growth could slow while interest rates remain elevated or even rise.
In addition, investors are increasingly questioning whether AI may also produce negative side effects. Entire sectors could become partially or largely redundant as AI replaces certain activities. This raises concerns about whether the massive investments currently being made in AI will ultimately generate sufficient returns. These concerns are amplified by the fact that a growing share of AI investment is being financed through debt.
In short, the impact of AI could evolve in either a strongly positive or a more adverse direction.
How Will the U.S. Budget Deficit Be Addressed?
The U.S. federal budget deficit and public debt have reached levels that many consider unsustainable. There is little indication that decisive corrective action will be taken in the near term. The key question is how policymakers will respond.
If governments opt for significant spending cuts and tax increases, economic growth would likely slow, and many companies would be adversely affected. Historically, however, similar situations have often resulted in central banks being compelled to finance deficits and debt through monetary expansion and more inflationary policies.
For financial markets, the implications of fiscal consolidation versus monetary financing are fundamentally different.
In the near term, attention is also focused on the forthcoming ruling by the Supreme Court on import tariffs. Should these tariffs be declared unlawful, the federal deficit could widen further.
Conclusion
Across several critical areas, outcomes could diverge significantly in the period ahead. For many markets, these developments will determine whether prices move higher or lower. At present, however, uncertainty is too elevated to make a clear directional forecast.
We aim to identify the likely trajectory as early as possible. Until greater clarity emerges, the probability remains high that markets will continue to trade sideways.
