War has broken out and no one knows when it will end. Energy costs are shooting up — and with them investors’ expectations of inflation around the world.
Traders are rapidly reassessing how hawkish central bankers will need to be to prevent prices more broadly from spiralling out of control. Uncertainty and the threat of higher interest rates are hammering stocks and government bonds, too.
In short, the shocks rippling through global markets feel much like those of February 2022, as Russia invaded Ukraine.
Then, the most worrying aspect of the crash that followed was that all sorts of asset prices which should be moving independently in fact plunged together.
If stocks and bonds both fall, while traditional havens such as gold offer little protection, financial outfits are more likely to start wobbling. Uncomfortably, the mayhem in markets sparked by the American-Israeli war against Iran looks like it, too, will batter asset prices across the board.
The current oil shock is in some ways even sharper than in 2022. In London’s early hours on March 9th, Brent crude, the global benchmark, fetched almost $US120 a barrel ($170), less than nearly $US130 after Russia’s invasion of Ukraine.
But that spike started from a higher base, such that the increase between the start of hostilities and a peak was 32 per cent, compared with more than 60 per cent this time, and over a much shorter period (see chart, below). Despite edging down later in the day, after the G7 club of rich economies said they were prepared to tap their strategic reserves, it remained around $US100. A few days ago traders considered this to be the worst-case scenario.
Worse, it comes at a time when investors were already feeling nervous. American stocks began this year looking, on some measures, even more expensive than at the peak of the previous mania in 2021. Stockmarkets in Europe and Asia have been on terrific rallies of their own, raising the potential for a sharp reversal.
Over the 12 months to February 27, Europe’s STOXX 600 index rose by 29 per cent, Japan’s TOPIX by 41 per cent and South Korea’s KOSPI by 150 per cent (all measured in dollars). Since then this trio has suffered the heaviest losses among big stockmarkets (see chart, below). Part of the sell-off, therefore, is probably down to investors taking profits on their most successful recent trades.
More ominous is the whiff, redolent of 2022, of several things going wrong at once. Europe, still adjusting to the loss of Russian natural gas, and Japan and South Korea, which are heavily dependent on oil from the Gulf, are also the most exposed to rising energy prices.
Traders in America, which is insulated from the oil shock by its domestic shale producers and considerable strategic oil reserves, are on edge as well. Wall Street’s “fear gauge”, the BIX index, which measures how wildly American share prices are expected to swing, is at its highest since the tariff-induced panic last April (see chart, below).
Although the S&P 500, America’s most-watched share index, had not moved much this year until hostilities began, the stockmarket has been churning furiously beneath the surface for months. By late February, jitters over the impact of artificial intelligence on software firms’ business models had pulled their share prices down by a third from a recent high. Those of most of America’s biggest tech behemoths peaked months ago.
Meanwhile, cracks have begun to appear in the market for private credit, an increasingly important lender to American firms, especially those developing AI.
On February 18 Blue Owl halted withdrawals from a private-credit fund aimed at retail investors, to give itself time to sell its assets. Other similar funds, notably at Blackstone, a private-investment giant, have faced a rush of redemptions from spooked clients.
Formally, these funds limit such withdrawals to 5 per cent of their net assets per quarter, since the assets they invest in are illiquid. In Blackstone’s case senior executives decided to waive this rule and stump up their own cash to meet the clamour.
Then there are the knock-on effects of rocketing energy costs, on stark display in government-bond markets. As in 2022, higher prices for oil and gas will fuel headline inflation, since energy is needed for virtually all goods and services.
Traders have trimmed bets that the Federal Reserve will cut interest rates. They are increasingly wagering that the Bank of England and European Central Bank — which oversee economies that are more exposed to global energy prices — will have to raise them. As a result, government-bond yields are rising sharply (and bond prices, which move inversely, are falling).
Europe’s greater vulnerability to the energy shock shows up in the magnitude of these moves. Since February 27th the yields on ten-year government bonds for America, Germany and Britain have risen by 0.19, 0.23 and 0.42 percentage points, respectively.
On top of the direct hit from higher inflation and interest rates, investors are betting that governments will feel obliged to subsidise citizens’ and firms’ energy bills, straining budgets. Their fiscal trouble will be worsened by the dampening effect of a higher oil price on economic growth.
At times like these investors yearn for havens. In contrast to the tariff panic in April, the dollar has appreciated against other currencies—but only barely. American Treasuries, another erstwhile refuge, have distinguished themselves by merely not doing as badly as other government bonds.
Gold has had such an astonishing winning streak over the past year that it looks more like a risk asset than a hedge. Its price has fallen since February 2. Investors are grimly recalling the worst aspect of the 2022 crash — that there was nowhere to hide.
https://thewest.com.au/business/the-economist/the-economist-the-iran-energy-shock-reverberates-across-financial-markets-c-21891948
