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It has been a rough week in markets, even for investors getting used to frequent whiplash under US President Donald Trump’s second administration. Nevertheless, beyond the tragedies of death and destruction from his and Israel’s war against Iran, and Tehran’s reckless retaliation, the potential magnitude of the conflict’s economic impact raises the question of whether markets are reacting anywhere near enough.
In many previous geopolitical crises oil price shocks have been the harbingers of widespread global economic damage. Brent, the international oil benchmark, broke past $90 per barrel on Friday, up from about $70 before the war began last weekend. In Europe natural gas prices nearly doubled, and power prices are gyrating wildly, as newly expensive gas alternates with lower-priced renewables in the energy mix.
Stocks have taken a hit, and bond markets, where yields have jumped, signal inflation fears. And yet: stock prices remain not far off where they were at the start of the year in most advanced markets. Traditional haven assets, from Swiss francs to gold, do not suggest any sudden rush of fear. Why the quiescence? Geopolitical analysts may warn investors against complacency. So far the warnings have been mostly shrugged off.
Those ringing alarm bells could still be right. The conflict in the Middle East is already metastasising more than most had thought. The longer it goes on the greater the disruption to vital global supply chains. Indeed, Trump’s ambition for regime change in Iran might point to long-term disruption in the fossil fuel-rich region, rather than the few weeks many are pricing for.
One explanation for the calm may be that investors are numbed, or stupefied, by what would once be extraordinary events. They may have also internalised expectations of Taco — Trump always chickens out (if markets sink) — to the extent that “markets will be fine” has become a self-fulfilling prophecy. But right now, it is not at all obvious how Trump could put the war genie back in the bottle if the market reaction becomes too negative.
The oil price channel from conflict to economic turmoil is also not what it used to be. The US shale revolution means there is more supply to help keep a lid on global prices. And advanced economies are much less oil-intensive than during the oil shocks of the 1970s.
Market reactions may also reflect that while the US is causing mayhem elsewhere, its own economic heartland could be fine. Because of shale, a rising oil price is now a positive terms of trade shock for the US. Natural gas, too, is in ample domestic supply for North American customers, unlike Asian ones who rely more heavily on shipments through the Strait of Hormuz. With US financial markets still dominating money flows around the world, the insulation of its domestic economy may shore up markets globally.
What could puncture this confidence? First, a prolonged and intensifying conflict in the Middle East. Next, a more serious economic fallout at home. On Friday, in another sign of a weakening labour market, we learnt the US economy shed 92,000 jobs in February. And though America may well be a net exporter of energy, the global oil price still feeds through to the petrol pump. This complicates matters for the US Federal Reserve. Finally, AI optimism, which has underpinned the strength of the US stock market, continues to look shaky.
With fresh uncertainty building, caution would be a wise move for investors. Some may be tempted to buy the dip. But the conflict and its economic ramifications are still playing out.
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