Wolf von Rotberg (J. Safra Sarasin Sustainable AM) | Although diplomatic efforts have intensified in recent days to prevent the regional effects of the October 7 attack by Hamas against Israeli civilians, serious risks remain.
Over the past 50 years, we have analyzed the evolution of asset prices during the Middle East conflict and, not surprisingly, we have found that oil is the most affected asset. Considering all the conflicts, the price of oil rose on average by almost 40%. Conflicts limited to the Israel/Palestine region produced an average price increase of 9%, which corresponds to the 8% increase in oil prices since the attacks. However, we recommend protecting against a new rise in tensions, especially with attractive positions even if the conflict remains contained. These include British equities, high-quality long/short credit, and the Norwegian krone.
Hamas attacks on Israeli villages two weeks ago not only caused unbearable pain to civilians and families but opened the door to increased violence in the Middle East. The geopolitical consequences of the actions are difficult to see, but the various actors and interests in the region make it possible for many risk scenarios to arise that may be reminiscent of the wars in the Middle East in the 1970s. However, this is not a given. .
Given the uncertainty surrounding possible developments, we look to past conflicts for possible guidance on how to protect against further escalation of the situation. The asset most affected by rising tensions in the Middle East is oil, as the region continues to produce more than a third of daily supplies. In particular, the production of Iran, the eighth global producer of crude oil, will be at risk if there is an increase. After Iran’s exports fell below 500,000 bbl/d in 2020, its production recovered to an estimated 1.5 million bbl/d in September, partly reflecting the relaxation of the application of sanctions. in the US. A new tightening of sanctions could eliminate up to 1 million barrels a day from global production. In addition, the increased uncertainty of supplies from Saudi Arabia could easily lead to a price increase similar to what happened in response to the invasion of Ukraine in 2022. In 2022, the price of oil increased by 30% within two weeks before the settlement was almost 15% above the pre-war level (Chart 1).
Historically, the average change in oil prices has been between 35% and 40% in response to rising tensions in the Middle East. However, what is clear is that every conflict is different and the oil market has also changed. The United States is now the largest producer of crude oil, which makes the market more resistant to a scenario like the oil embargo of the 1970s when prices increased by more than three. Furthermore, while the spread of conflict in the Israel/Palestine region can be controlled locally, the impact of oil is relatively modest. Typically, prices rise only 9% in a local conflict, putting the 8% increase in the last two weeks where it should be (Chart 2).
The only other asset that saw a significant move in the last two weeks was gold, up 6% from the attacks. Surprisingly, it has an 11 basis point increase in US 10-year bond yields, indicating that fixed-income markets have not really noticed the attack and so far have not priced in a significant impact on the global cycle.
Some properties barely work in response to an attack. US equities were flat and currency markets were largely unchanged. We expect these movements to remain limited and have little impact on asset prices, as long as it is safe to assume that the conflict does not spread to other parts of the region. In this sense, the diplomatic efforts of recent days can be considered positive, where restraint is requested and that other parties remain in the conflict.
However, although the probability of a sharp decline has decreased in recent days, we recommend three hedges against a possible worsening of the situation, which we also consider attractive themselves:
- In equities, the British market will benefit from rising oil prices and strengthening the US dollar. This is due to the substantial weighting of energy in the index and the high exposure to foreign income. The UK equity market is also one of the most defensive indices in the world, favored by lower rates at the high end of the curve, in a risk-averse scenario.
- Of the types, we recommend a significant amount of quality duration. The US curve should flatten if oil prices rise. The imminent inflationary pressures will be met by greater recessionary risks and a wider credit distribution.
- In the currency market, the Norwegian krone looks good when oil prices rise. It typically appreciates by around 4% (trade-weighted) for every 20% change in Brent prices but has recently lagged by around 5%. A significant increase in oil prices above $100/bbl would mean a 5% to 10% appreciation for the trade-weighted Norwegian krone.