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Escalating tensions in the Middle East are causing a new shock to global markets

By Lucy Raitano and Dhara Ranasinghe

LONDON (Reuters) – Reports of an Israeli attack on Iranian territory that could drag the Middle East into deeper conflict have rattled global markets with geopolitical risks that could quickly change the direction of everything from oil to bonds and increase inflation risk enlarge.

Stock prices plunged on Friday, oil prices briefly rose more than $3 a barrel and safe-haven government bonds rose.

The moves were relatively modest, but increased tensions are creating new uncertainty and fueling concerns that high oil prices and potential supply disruptions will keep inflation high.

“Even if these seem like more favorable telegraphs between Iran and Israel, and the base case is not that we have a broader conflict, you probably have to price in more risk premiums,” said Tim Graf, head of the Israeli army. of the macro strategy for Europe on State Street Global Markets.

Here’s a look at the key insights for markets.

1/ OH OIL

Oil prices are up about 13% so far this year, almost $90 a barrel, and are expected to remain high.

The International Monetary Fund on Tuesday described a “negative scenario” in which an escalation in the Middle East leads to a 15% oil increase and higher shipping costs, which would increase global inflation by about 0.7 percentage points.

The tight oil supply and higher prices are being supported by the oil producing group OPEC and other major oil producers cutting production.

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Morgan Stanley has raised its third-quarter Brent crude forecast to $94.

“It appears there is a geopolitical risk premium built into the oil price, but further escalation obviously brings even more upside risks,” said Thomas McGarrity, head of equities at RBC Wealth Management.

2/ INFLATION ROUND TWO

Shocked by the latest high inflation figures in the US, investors are looking to oil. It was a rise in energy prices two years ago that helped drive up inflation and interest rates.

High oil prices threaten the downward movement of inflation and could prompt a further revaluation of bets on global interest rate cuts.

A key market gauge of long-term inflation expectations in the euro zone, which typically tracks oil, reached its highest level since December at 2.39% on Tuesday. It remains above the European Central Bank’s 2% inflation target.

The ECB has said it is “very alert” to the impact of oil, which could harm economic growth and boost inflation.

3/ GO ENERGY RECOMMENDATIONS

Energy stocks are a winner from higher oil prices.

The S&P 500 oil index and European oil and gas stocks hit record highs earlier in April before retreating.

U.S. oil stocks are up nearly 12% so far this year, outperforming the broader S&P 500’s 5% gain.

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Yardeni Research recommends an ‘overweight’ position on energy stocks, with a rise in Brent crude to $100 in the coming weeks as a possibility.

Oil briefly spiked to around $139 after Russia invaded Ukraine in 2022, the highest level since 2008.

“The rise in oil prices is complicating central banks’ efforts to bring inflation back to target levels,” RBC’s McGarrity said. “Having exposure to the energy sector arguably provides the best coverage for both inflation and geopolitical risks in equity portfolios in the short term.”

4/ RUSH IN A SAFE COINCIDENCE

The demand for safe havens such as US and German bonds – especially before the weekend – exceeds the urge to sell bonds, given the renewed inflation risks of rising oil for the time being.

U.S. 10-year Treasury yields fell as much as 15 basis points on Friday and were last down 6.5 basis points at 4.58%, down from recent five-month highs.

“That suggests markets are more concerned about the need for safe havens than the direct inflationary consequences of higher energy prices,” said Philip Shaw, chief economist at Investec.

The dollar and Swiss franc have also benefited from safe-haven demand, with geopolitics and high oil prices contributing to a rally in the dollar, fueled by the scaling back of US interest rate cuts.

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The dollar’s strength is adding pressure on economies such as Japan, which are struggling with a yen at a 34-year low, with traders nervous about possible central bank interventions.

ING currency analyst Francesco Pesole said further escalation in the Middle East could lead to losses for currencies in New Zealand, Australia, Sweden and Norway as risk sentiment takes a hit; the Swiss franc could rise further.

5/ FRESH EM PAIN

Rising oil prices and a strong dollar are also hurting emerging markets such as India and Turkey, which are net oil importers.

The Indian rupee hit a record low this week.

Even for Nigeria and Angola, typically Africa’s top oil exporters, the weakening of the local currency and rising fuel prices have hit public coffers due to limited petrol pump prices and a lack of local oil refining.

“A return to $100+ oil prices could convince the Fed to throw in the towel for now on hopes for monetary easing, and a potentially greater impact from geopolitical risks on emerging currencies could prompt a substantial rotation back to the dollar can fuel,” said Pesole. .

(Reporting by Lucy Raitano and Dhara Ranasinghe; additional reporting by Libby George and Harry Roberston; graphics by Kripa Jayaram, Prinz Magtulis, Vineet Sachdev, Riddhima Talwan; editing by Chizu Nomiyama)

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