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- Muted financial markets reaction to Middle East crisis
- Key source of volatility will arise from surging energy prices and its knock-on effects on inflation
- Further developments are contingent on whether this conflict can be contained
- Historical data suggest a marginal increase in oil price and slight pullback in equities
- Stay with quality growth plays for equities and the Liquid+ Strategy for credit
Muted market reaction. The Israel-Hamas conflict is tragic from a humanitarian standpoint, and we hope the tension will be contained in the coming months. In financial markets, the impact has been minimal thus far. As with past conflicts in the Middle East, a key source of market volatility will arise from surging energy prices, and its knock-on effects on inflation and the broader economy.
As news of the conflict broke, the expected increase in energy prices took hold, with commodities rallying some 5% when the market re-opened on Monday (9 October). However, the classic flight-to-safety and selldown in risk assets did not materialise:
- US Dollar Index was only slightly higher while UST 10-yr yield saw a modest decline
- Global equities closed higher
So where do we go from here? Whether this crisis escalates further into a long-drawn affair which may significantly impact the global economy will depend on whether the geopolitical upheaval can be contained and not trigger intense involvement of other nations. There are no easy answers – it all hinges on how the situation evolves over the next few days.
Middle East conflicts: Historically muted impact on financial markets. Beyond current headlines and knee-jerk reactions, our analysis of past data suggests that market reaction to these conflicts in the longer-term were minimal. Since 2000, there were a total of 6 of such conflicts. On average:
- Oil price was up 0.6% one-month after the conflict, while the S&P 500 dipped 0.8%
- Safe haven assets such as bonds and the US Dollar Index (DXY) were up 0.3% and 0.7% respectively. Contrary to conventional wisdom, gold has fallen 1.3% on average
Barring further escalation, we believe this time shall be no different and overall impact on risk assets will be limited.
Tactical strategies for volatile times: Stay with quality. Listed below are our tactical strategies in the current environment:
- Equities: The main impact on equities will come via the inflation-bond yield channel. But with the UST 10-yr yield having already moved up 100 bps over the recent quarter, and a reasonable degree of downside already priced into equity markets, the impact from the crisis will be muted. Investors are advised to stick with quality plays and companies that benefit from secular trends.
- Credit: While the upheaveal is likely to have marginal negative effect on credit spreads from a sentiment perspective, we opine this conflict has no direct impact on overall corporate credit risk. Nonetheless, in the face of rising geopolitical headwinds, we continue to advocate our Liquid+ Strategy of high quality, short duration bonds to add stability to a portfolio.
- Rates: Impact on long-end bond yields will be muted, especially after the recent 100 bps move on the UST 10-yr yield. While the potential increase in energy prices (and by extension, inflation) could push long-end yields higher, this will be likely be offset by higher demand for safe haven assets.
Figure 1: Relationship between oil and inflation
Source: Bloomberg, DBS
Table 1: Major Israel-related conflicts since 2020
Source: Britannica, Journal of Conflict Studies, Institute for Middle East Understanding, Bloomberg
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