On October 7th, Hamas launched an unprecedented attack on Israel that shocked the world. It has been two weeks since the conflict began, and geopolitical tensions are extremely high. While the situation remains highly fluid, investors are beginning to wonder what the longer-term implications could be in terms of markets and geopolitics. While we are not geopolitical analysts, we wanted to highlight how the markets have reacted thus far and explain some of the risks that could develop if it turns into a broader and longer conflict.
- Global equities lower: The MSCI AC World Index and S&P 500 are lower since the start of the conflict (both down ~2% since Oct. 6th). In addition, volatility in U.S. equity markets, as tracked by the VIX Index, has surged ~20% since the start of the conflict.
- Treasury yields at multi-decade highs: Instead of being the traditional flight to safety asset, Treasuries have deteriorated in recent weeks. The yield on the 2YR U.S. Treasury note remains above 5% and the 10YR yield flirts with 5% (as yields rise, prices fall). Investors are cautious about the inflation impact as crude oil prices remain heightened.
- Gold takes over safe-haven leadership: As investors flee bonds as a safe-haven asset, they are turning to other safe-haven assets, specifically precious metals. Gold and silver prices have both jumped ~8% since the start of the conflict.
- Energy prices on the rise: Crude oil has seen volatile price swings over the last two weeks and is 7% higher since the conflict began. However, it is still below the high seen year to date ($93.68 on September 27, 2023). Additionally, there is growing anxiety that we can see a similar situation to the 1973 oil embargo. At that time Arab nations punished the U.S. for supporting Israel during the Yom Kippur war (October 1973). During the oil embargo period, WTI crude prices increased by ~300% from $2.90/bbl. to $11.65/bbl.
- History tells us inflation can remain stubborn: History shows wars and geopolitical tensions, especially in the Middle East, tend to cause headline inflation to spike. Specifically, when analyzing the Yom Kippur war (October 1973) and Iranian Revolution era (January 1978). During those periods, the headline Consumer Price Index took ~15 months on average to reach a peak and increased by an average of 440 bps. If similar trends were to take shape today, that would lead headline CPI inflation to peak around December 2024 at ~8.1%.
The Bottom Line:
We are not geopolitical analysts and we do not know how long or to what extent the conflict in the Middle East will escalate. However, we have witnessed markets fall slightly since the conflict began. Some better than expected economic data out of the U.S. has limited the risk off sentiment from investors. Geopolitics have always been a risk for global investors with the degree of risk ebbing and flowing over long time periods. What we do know is that typically geopolitlcal conflicts, especially in the Middle East, can be inflationary through higher oil prices. This comes at a difficult time for the Fed who has spent the past 19 months working to get inflation under control. Unfortunately, the result is likely higher rates for longer (possibly another rate hike) and this should put pressure on an already fragile economy. In addition, volatility in equities is likely to stay as the conflict continues.