Escalating tensions in the Middle East have pushed oil prices sharply higher overnight and into today, unsettling global markets, prompting investors to reassess the outlook for inflation, growth and interest rates. Brent crude has climbed above $100 per barrel while bond yields have risen and equities have come under pressure.
Below, Paul Diggle, Chief Economist at Aberdeen, and fixed income investment directors Luke Hickmore and Mark Munro outline their views on the market impact and risks for the months ahead.
Paul Diggle, Chief Economist, at Aberdeen said;
“Brent crude oil prices are $105 at the time of writing, and peaked at $116 earlier in the Asia morning. Equity markets/futures have been selling off today between 0.5% and 6.5%, with China and the US at the lower end of that range, and Europe and Asia excluding China at the higher end. Meanwhile, the dollar is higher, bond yields are higher, and gold prices are lower. We continue to think the news flow points to more still to come.
Even after the further rise in oil prices today, we continue to warn that the oil price impact of the conflict is a non-linear function of its duration. So, there may potentially be further moves higher, before the eventual decline. We think $120 per barrel is easily in reach. If prices do then fall back, the global economic cycle would have a more stagflationary feel but wouldn’t be fundamentally derailed. But we are starting to think about sustained stagflationary scenarios involving $150 per barrel peaks and a forward path well above $100 for many months.”
Commenting on the bond market’s reaction to developments in Middle East, Luke Hickmore, Investment Director, Fixed Income, at Aberdeen said;
“The bond market is very focused on the problems that could be coming down the line from higher hydrocarbon prices, in particular the natural gas price impact on Europe and the UK. Gilts have been a very poor performer during the move, with 10-year gilt yields moving higher by around 0.5% during this conflict, and shorter dated gilts now moving to price in a rate hike by the Bank of England in June.
Contrasting this, investment grade credit has not been moving to price in economic stress in any major way, reports from the market are that spreads (the extra yield you get for corporate credit) have moved a little but still reflect the excellent fundamental quality of most large businesses in this environment. That is likely to be where the risk lies in the next few weeks, if we see continued supply issues in oil and gas, that have a lasting scaring impact on corporate quality, expect corporate credit to underperform.
We have been moving to better quality in credit markets for the last few months, reducing risk and holding more cash than we would normally have. It is not yet the time to be putting that cash to work.”
Mark Munro, Investment Director, Fixed Income, at Aberdeen added;
“The move higher in Government bond yields is doing some of the heavy lifting and prevented credit spreads from moving wider as much as we might have thought before the conflict began.
It’s too early to be adding risk, you require de-escalation headlines (we have had the opposite), enough time to pass that a de-escalation feedback loop emerges (we have clearly not had enough time for that yet) or extreme valuations (as mentioned above credit spreads have not moved enough yet).
Many are now dusting off the historical play-books as to what is required for a worsening of the situation. We would note that the energy price spikes have to be sustained over several months, a hawkish policy response from central banks or signs that it is damaging macro data pointing towards recession. That is not to say that some of these markers are not realised but none of them are in sight right now.”
