During the Columbus Day trading session, the Israel-Hamas war rattled US financial markets, prompting investors to flee to safe-haven assets like gold, the US dollar, and Treasurys. Residents inside the New York Stock Exchange have calmed down, and everyone on Wall Street is monitoring the situation safely 5,600 miles away. As is typically the case in geopolitical shocks and other types of disruptions, investors and their algorithms have started pricing in every scenario possible, diminishing the volatility that observers would expect.
Israel-Hamas War and Markets
When the military conflict started in Eastern Europe, global stock markets panicked as participants looked ahead and baked everything into the cake, waiting for the next catalyst to drive equities. Nearly two years later, it is no different. Hamas launched a devastating attack on Israel, the international community offers its condolences, and market analysts weigh various circumstances. Considering that the economies of Israel, the West Bank, and Gaza contribute very little to the global gross domestic product, traders are not too concerned. However, everything could change if it is confirmed by the US government that Iran played a role in the strike. Why would this matter? It is all about oil.
Tehran has seen its energy industry resuscitated this year as crude production and exports are at their highest levels since 2018. This has eased pressures on worldwide oil markets. Should the United States and its allies reapply sanctions and restrictions on Iran, market analysts warn that crude prices could climb to as high as $150. Will prices reach this level? Probably not.
While there is a global supply deficit, if black gold were on track to reach this level, West Texas Intermediate (WTI) and Brent would have likely rallied a lot more than 4% on Oct. 9. Indeed, $100 is more plausible, especially as US output stalls, domestic inventories shrink, and the national economy achieves the much-anticipated soft landing. Plus, the Organization of the Petroleum Exporting Countries (OPEC) and its allies, OPEC+, are still cutting production and shipments heading into 2024.
Marko Papic, the chief strategist at Clocktower Group, might have said it best in an interview with MarketWatch regarding Israeli-Palestinian conflicts over the last 20 years: “I am open minded that this can change, but thus far ‘what happens in the Levant, stays in the Levant’ has been a reality.'”
An Eye on China
One of the reasons why oil prices have not risen as much as they should have, based on supply data, is China. Beijing has struggled since abandoning most of its pandemic-era public health restrictions, resulting in the Chinese Communist Party unleashing various fiscal stimulus tools. This has not been enough as manufacturing activity contracts, growth comes below consensus estimates, and consumer demand slumps. Wall Street analysts have also trimmed their forecasts for 2023 and 2024.
Citing sources, Bloomberg reports that policymakers are considering more lavish deficit-financed spending and other stimulus measures to revitalize the Red Dragon. “Policymakers are weighing the issuance of at least 1 trillion yuan ($137 billion) of additional sovereign debt for spending on infrastructure such as water conservancy projects,” the business news network stated.
It is unclear if this would be enough, as economists assert that China needs to do more than a 15-basis-point cut to a key interest rate and a tepid reduction to the reserve requirement ratio (RRR). But all eyes will be on the third-quarter GDP, projected to come in at 4.4%. Meanwhile, whether the numbers are abysmal or robust, it might prove to be good news for oil prices in the long run: Beijing responds with more stimulus or decent expansion will support crude demand.
Fed and Interest Rates
Has the Federal Reserve raised interest rates high enough? The answer might depend on the September and October inflation rates. The Summary of Economic Projections released at last month’s Federal Open Market Committee policy meeting revealed one more rate hike before the year is finished, as the median rate is forecast to be 5.6% this year.
The talk from officials has been mixed. For example, Cleveland Fed Bank President Loretta Mester and Fed Gov. Michelle Bowman say higher rates are warranted to ensure above-trend inflation is vanquished from the economic landscape. Atlanta Fed Bank President Raphael Bostic contends that rates are high enough, and it is important not to over tighten and break the economy. Fed Vice Chair for Supervision Michael S. Barr argues that this is the crucial question policymakers are grappling with: How long should the Eccles Building leave interest rates high?
The US central bank is currently engaged in a balancing act as it weighs many factors: the Israel-Hamas war, another government shutdown fight, elevated inflation, rising energy prices, and slowing growth. At this stage, it is fair to say that Fed Chair Jerome Powell is looking forward to the end of his second term.