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The Watchful Peace was a relatively peaceful 4-century period during the Third Age, from T.A. 2063 until Sauron's return to Dol Guldur in 2460. During this time Dol Guldur was ruled by Khamûl the Easterling in the Absence of the Necromancer.
It was during this period that the Witch-king of Angmar had overthrown the Northern Kingdom of Arnor and its three successor kingdoms: Arthedain, Rhudaur, and Cardolan. The Elves of Rivendell however destroyed Angmar not long after.
The later years saw also the Nazgûl gathering back in Mordor and subsequently the capture of Minas Ithil, now renamed Minas Morgul. The Dwarves of Moria also suffered a big setback with the awakening of a Balrog and subsequently the evacuation of Khazad-dûm.
The first ten Ruling Stewards had relative calm in which to renew their strength. During the Watchful Peace Gondor strengthened its borders, keeping a watchful eye on the east, as Minas Morgul was still a threat on their flank and Mordor was still occupied with Orcs. But no major escalations occurred except for minor skirmishes with the Haven of Umbar. Stewards of Gondor during the Watchful Peace included Mardil Voronwë, Eradan, Herion, Belegorn, Húrin I, Túrin I, Hador, Barahir, Dior, and Denethor I.
The first seven Chieftains of the Dúnedain reigned during the Watchful Peace: Aranarth, Arahael, Aranuir, Aravir, Aragorn I, Araglas, and Arahad I. The region suffered from wolves and other evil creatures.
At the beginning of the Watchful Peace, the Dwarves of Durin's folk dwelt in both the Grey Mountains and in Erebor. Thráin I made his abode at Erebor, but the majority of his people inhabited the Grey Mountains and his son Thorin I moved there as well. He was followed as King of Durin's Folk by Glóin and Óin.
End of the Peace
A new race of Orcs was bred in Minas Morgul, the Uruk-hai. But Sauron was not idle in the east either: he created a strong alliance between the various tribes of Easterlings, so that when he returned he was more powerful and had many Men in his service.