By Dhara Ranasinghe and Alun John
LONDON (Reuters) – Conflict in the Middle East is escalating again, but the mood in financial markets remains positive for now due to shifts in oil production and as global interest rate cuts overshadow geopolitics.
Israel, which is still fighting Hamas in Gaza, bombed Beirut on Thursday as it continued its conflict with the Lebanese group Hezbollah days after it was attacked by Iran.
Yet MSCI’s world stock index is just 1% below last week’s record highs and oil prices, which rose about 5% in the 24 hours after Iran’s missile attack on Israel, have remained steady at around a threatening $75 per barrel level.
Certainly, a larger escalation that disrupts oil supplies from the Middle East and shakes the global economy would trigger a bigger response, and the fact that stock markets are near record highs could leave them vulnerable to sharp declines.
But for now, markets are dampened by the prospect of more monetary easing and by the United States’ increased role in oil production, which has offset the dominance of the Middle East.
Wall Street’s so-called fear gauge, the VIX volatility index, is at a subdued level around 20 – well below a post-pandemic peak above 60 reached during the market turbulence in early August, coupled with a weakening of global carry trades .
“As we think about geopolitical risk and its transmission in asset prices, it will clearly have a greater impact if we see outcomes that have a material impact on growth or inflation,” said Mark Dowding, Chief Investment Officer of BlueBay Asset Management.
“The biggest concern was actually the transmission impact on oil prices. But even here we’ve been in a situation where the oil price has been falling anyway.”
The fact that the United States has become a major oil producer – the world’s largest in the past six years – has reduced global sensitivity to supply disruptions in the Middle East, analysts say.
And European energy markets have reorganized themselves since Russia’s invasion of Ukraine, which was a dramatic example of how a rise in energy prices can roil global markets and economies.
“The growing importance of the US would indicate that risks to energy supplies from rising tensions in the Middle East have been somewhat mitigated,” said Katharine Neiss, chief Europe economist at PGIM Fixed Income.
DIFFERENT TIMES
In 2022, when Russia invaded Ukraine, oil prices rose above $100 and gas prices soared, creating a new wave of inflation that increased pressure on central banks to raise interest rates, pushing bond yields higher, especially in the US, which in turn caused government bond yields to rise. the dollar.
The situation today is different. Central banks are already easing and are hopeful that the US will avoid a recession.
The global economy is not ready for an oil shock, says Trevor Greetham, head of multi-asset at Royal London Asset Management, because the global economy is in a “softer phase of the cycle”.
That’s in contrast to 2022, “when Ukraine happened, you were already in that period where you were just starting to get very high inflation rates,” Greetham said.
The current backdrop of looser monetary policy is supporting investor sentiment, even as tensions rise in the Middle East.
Tilmann Kolb, emerging markets strategist at UBS Global Wealth Management, said that while the past two years have seen significant developments in domestic and international politics, the economic outlook for markets remained critical.
“Where is inflation going? How is the Fed responding? Will growth hold up?” he said.
Meanwhile, investors have been jumping on announcements of long-awaited economic stimulus from China, which has lifted Chinese stocks and lifted global assets from luxury stocks to industrial metals and mining companies.
“The impact of China delivering a big policy stimulus last week was almost a more important factor in terms of what it means for global demand and growth,” BlueBay’s Dowding said.
RISK ON TO RISK OFF
Of course, the dial could turn very quickly, and oil itself remains the transmission mechanism as geopolitics heats up further.
Tina Fordham, founder and geopolitical strategist at Fordham Global Foresight, said she was watching to see whether Israel would target Iran’s energy infrastructure or its nuclear facility.
“Each of these objectives would result in an impact on the market,” she said.
“Where this could become more problematic is, for example, if Ukraine simultaneously targets Russia’s energy infrastructure.”
And with stock markets near record highs, there is room for dramatic falls, policymakers warn.
The Bank of England said on Wednesday that global asset prices remain under pressure and are vulnerable to a big drop, as investors become increasingly concerned about geopolitical risks.
And according to Andrew Bresler, CEO of Saxo UK, assets are mispriced given the geopolitical risks, adding that volatility indicators such as the VIX should be higher.
“I find it a little disturbing how insensitive the markets are to geopolitical risks,” he said.
(Reporting by Dhara Ranasinghe and Alun John, additional reporting by Naomi Rovnick; images by Amanda Cooper, editing by Susan Fenton)
