Further tensions and conflict have added to investor concerns over stability in the Middle East, pushing financial markets into adopting a cautious stance and kicking off a search for ‘haven’ assets. The shift in sentiment towards risk-off positioning has meant that valuations of equities have fallen, while those of bonds have risen. In foreign exchange markets, the US dollar has appreciated against other currencies. Supply concerns have set oil prices soaring.
While this is a typical – initial – reaction, caution has lingered as tit-for-tat air strikes between Israel and Iran continue. Comments by US President Donald Trump that he could ‘easily’ end the conflict and ‘many meetings’ were being held have provided little lasting comfort. With the US calling for Iran to surrender ‘unconditionally’, concerns have spread that the US might be drawn militarily into the conflict.
Oil prices have moved erratically, underscoring the reluctance by investors to position themselves one way or another given the lack of visibility on the course of the conflict, its eventual impact on local oil infrastructure and the chances of the Strait of Hormuz – an oil supply chokepoint in the region – being impacted. Still, we note that the rise in oil prices has, so far, been limited.
How to measure geopolitical risk and its effects? Federal Reserve Board researchers Dario Caldara and Matteo Iacoviello have constructed a measure based on a tally of newspaper articles covering geopolitical tensions.
Their findings are that “higher geopolitical risk foreshadows lower investment, stock prices, and employment. Higher geopolitical risk is also associated with higher probability of economic disasters and with larger downside risks to the global economy”.
Arguably, geopolitics does matter for investors, but in our view, it is difficult to base an asset allocation on ‘known unknown risks’. Stay tuned!
