The horrific scenes coming from Israel after the attacks from Hamas have shocked the world, as another geopolitical risk comes into focus. Israel has declared war on Hamas and a siege on Gaza, and so far, the death toll is over 1,000.
Above all, it’s sadly had a devastating human impact and the overriding concern is for those who’ve been caught up in the conflict. However, with tensions rising sharply in the Middle East, this can also have a big impact on the global economy and financial markets.
How have stock markets reacted?
The direct impact of geopolitical events on financial markets can be short lived. For example, US shares managed to rally on the first trading day after the attacks, with US blue-chip shares rising by more than 1%.
The reason why the impact was so short lived is that the fundamentals of US and global shares are complicated. The Israel conflict comes at a time of ongoing geopolitical concerns. There are also economic concerns, and the International Monetary Fund (IMF) is expected to cut global growth forecasts at their October summit with the World Bank.
Uncertainty about monetary policy in the west is also dominating market sentiment.
Against this thorny backdrop, you might expect risky assets like shares to falter. However, stock markets are impacted by lots of different things.
On Monday, two Federal Reserve (Fed) officials hinted that there might not be further interest rate hikes this year. This impacted market-based expectations for US interest rates – expectations for interest rates to remain at 5.25%-5.5% for the rest of the year rose to 74%, up from 57% a week before. When interest rate expectations decline, this can boost risky assets like shares.
While western stock markets were relatively unscathed from the events in the Middle East, local markets were deeply affected. For example, there were significant declines in stock indices in Israel, Palestine, Turkey, Qatar, the UAE, and Saudi Arabia in the immediate aftermath of the attacks.
The Israeli government was also forced to intervene to protect its currency. It sold up to $30bn to support the Shekel, which fell to its lowest level since 2016, after the attacks.
For countries not directly involved, the financial impact can be smaller and shorter. However, the second-round effects of geopolitical crises can be profound.
What’s happened to the price of oil?
When there’s an escalation in violence in the Middle East, the oil market can be impacted.
In the immediate aftermath of the Israeli attacks, the price of Brent crude jumped by 3.5% to above $88 per barrel. This has stemmed the recent decline in the oil price, and with the Israeli prime minister stating that the campaign against Gaza is only “just getting started”, the rise in the oil price could be permanent. This could well feed into higher inflation.
Conflict in the Middle East can be inflationary because of the importance of oil production to the region. The Middle East accounts for just under a third of global oil production. A war in the region can increase the risk of a major interruption to the oil supply.
If the oil price continues to rise, then the impact of these attacks could show up in consumer inflation expectations in the west in the coming months. This could then impact interest rate expectations and investor sentiment.
The impact on ‘safe-haven’ assets
Geopolitics can also trigger a flow of money into ‘safe-haven’ assets. These are a group of investments that are expected to maintain or increase their value in the event of a geopolitical crisis, terrorism, or natural disasters. They’re thought to offer a degree of ‘safety’ to investors, but of course that’s not always guaranteed.
The most popular safe-haven investments include gold, short-term US treasuries (US government debt), and some currencies like the US dollar, the Japanese yen, and the Swiss franc.
Some defensive shares are also considered safe havens, for example, utility shares, energy shares and consumer staples. Unsurprisingly, in the immediate aftermath of the attacks, energy shares around the world rose sharply. In the US, the energy sector rose more than 3%.
How ‘safe’ are safe-haven assets?
Safe-haven assets tend to be more liquid, which means they’re easier to buy and sell. But there are signs that traditional safe-haven assets, including US government debt and the US dollar, are losing their potency in a crisis.
For example, research from the US’s National Bureau of Economic Research showed the US dollar appreciated in March 2020 at the height of the pandemic. However, the degree of appreciation for the dollar versus other currencies was smaller than during the financial crisis in 2008.
Likewise, while treasury bonds typically rally in times of turmoil, the performance of treasuries during recent crises hasn’t followed a pattern. We didn’t see long-term treasuries attract safe-haven flows in March 2020, and instead treasury yields rose sharply (meaning prices fell). Five-year treasury notes yield also rose.
Some think the large and growing size of the US deficit has weakened the position of the US dollar and treasuries as safe-haven assets. That’s because they threaten the US position at the centre of the financial system.
If we see the US get dragged into the latest conflict in the Middle East, it could also impact US assets’ claim to be safe havens.
What should investors do?
Geopolitical risks can have major long and short-term impacts on financial markets and the global economy. There could also be a structural shift in safe-haven assets.
But while it’s important to be cautious around major global events, that doesn’t mean making big knee-jerk changes to your portfolio.
Make sure you’re happy with how much risk you’re taking and that your portfolio is well-diversified – that means spreading your money across lots of different types of investments, sectors and regions. And remember, a long-term view is essential.
This article isn’t personal advice, if you’re not sure what’s right for you, ask for financial advice. All investments and any income from them can rise and fall in value, so you could get back less than you invest.
Kathleen Brooks is the Founder of Minerva Analysis, a market analysis company. Hargreaves Lansdown may not share the views of the author.
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