Investors are bracing for a fresh bout of market volatility this week following the resumption of fighting in the Middle East and a blockbuster US jobs report.
Oil prices have spiked once again after Israel conducted airstrikes in Beirut over the weekend and Iran fired missiles in response, despite ongoing peace negotiations.
The price of Brent crude oil climbed 4.2% to $97 per barrel while WTI rose 4.3% to $94.
The status of the negotiations and the Strait of Hormuz remain uncertain, although President Donald Trump has insisted a deal is still close to being reached.
This military action followed a surprising US jobs report on Friday, with non-farm payrolls expanding 175,000 in May, more than double consensus forecasts of 85,000.
The combination of these two factors undoubtably creates inflationary pressure, which could tie the hands of new Federal Reserve chair Kevin Warsh and his FOMC colleagues.
Warsh has widely been perceived as inclined to push for rate cuts, but that may prove a very hard sell if inflation rises. Some forecasters even suggest rate hikes may be needed.
Such a scenario could well put the brakes on the current equities bull market, and investors responded accordingly on Friday, as a deep sell-off took place.
The S&P 500 fell 2.6% while the Nasdaq shed 4.2% as tech stocks took a particularly hard hit.
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As the new week begins, the central question is whether prices corrected enough on Friday, or if another leg down is coming.
The FTSE 100 has not provided a strong signal so far on Monday, dipping 0.2% to 10,348 points.
Dan Coatsworth, head of markets at AJ Bell, said: “Hopes have been dashed for the two key things investors desperately wanted; an end to the Iran war and interest rates not to go up.
“Investors have been on the edge of their seat waiting for a breakthrough in Middle East negotiations. Renewed fighting between Iran and Israel has thrown cold water on the prospect of a resolution any time soon, meaning the focus shifts back to worries about oil supplies and what that means for inflation.
“Oil staying higher for longer will push up energy and transport costs, which in turn could lead to a pullback in economic activity,” he continued.
“Central banks would normally raise rates to fight inflation, and there have been market expectations for a hike ever since the Iran war began. In theory, a sustained inflation shock could hurt the economy and central banks would eventually cut rates to stimulate spending,” the AJ Bell analyst said.
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Richard Carter, head of fixed interest research at Quilter Cheviot, added: “The US economy has smashed expectations with nonfarm payroll numbers coming in well above estimates.
“Hourly earnings were up almost 3.5% too, and although this was slightly down on last month, it highlights that the economy remains robust enough to withstand the fallout of the Middle East conflict,” Carter added.
“Ultimately, the Federal Reserve is going to have little choice but to keep interest rates higher for longer once again. With Kevin Warsh joining as chair, he is going to have a very difficult time balancing the needs of the economy with the desires of the president.
“With the labour market looking this strong, and supposedly a deal imminent between the US and Iran, rate cuts will not be forthcoming soon, and if anything hikes still remain a real possibility.”
