Global markets continued to sell off on Thursday as Middle East tensions showed no sign of easing. Oil prices extended their rise. At its peak, US crude flirted with $83pb, while Brent crude approached $85pb. Sovereign yields continued to trend higher as well, amid growing worries that rising oil prices could force major central banks to tighten policy to fight a likely – and potentially notable – impact on inflation.
Announcements of potential measures from the US government to tame the oil price rally helped pour some cold water on the surge. These measures include a possible release of strategic oil reserves, loosening fuel-blending requirements, issuing a general licence allowing Russian oil sales to India (uh huh!), or even US Treasury trading oil futures – the latter would be unprecedented.
Now, US trading of oil futures could help counter speculation, but many doubt that government selling of oil futures would sustainably cap prices because the physical market ultimately drives pricing. Benchmarks such as Brent crude and West Texas Intermediate crude oil are tied to real supply and demand, so if a conflict in the Middle East disrupts flows for a prolonged period – say weeks or months – especially through chokepoints like the Strait of Hormuz, refiners will still bid up physical barrels regardless of financial selling.
On top of that, the oil futures market is enormous and highly liquid on exchanges such as CME Group and Intercontinental Exchange, meaning government intervention could easily be absorbed unless it were extremely large. As such, there is a risk that traders would see such selling as temporary and buy the dip, limiting its impact on prices – a bit like USD/JPY interventions.
So unsurprisingly, oil is pushing higher again this morning and sovereign yields are rising, though Asian indices are rebounding slightly and US and European futures trade in the green after a harsh week that saw the MSCI World ex-US shed more than 5% at its worst since Monday, while US indices delivered a relatively muted reaction to the war headlines.
The US benefited from its energy producer status. The US dollar saw strong inflows as investors sold their European and Asian holdings – reversing the earlier rotation trade – and moved back into US dollar. The dollar has the advantage of naturally benefiting when energy prices rise, as most energy trade is denominated in dollars and rising energy prices increase the dollar demand, pushing its price higher.
This combination of rising energy prices, more hawkish central bank expectations, higher yields and weaker appetite for risk assets will likely remain in play as long as Middle East tensions have a lasting impact on oil and gas prices.
For central bank watchers, it means that inflation dynamics may regain the upper hand in the coming months. This shift matters particularly for Federal Reserve (Fed) watchers – so essentially all of us – because the Fed had recently shifted its focus toward protecting the labour market while tolerating inflation running meaningfully above its 2% target. US inflation has been relatively stable around the 3% mark. But if price pressures start to build and push inflation – already running stubbornly above target – even higher, the Fed could forget about the two rate cuts that were broadly priced in before the Middle East conflict escalated.
So today’s US jobs data would ideally come in strong to keep market sentiment as positive as possible heading into the weekend. Weak data would struggle to fuel dovish Fed expectations at a time when inflation risks are rising alongside energy prices. The US economy is expected to have added around 58K new nonfarm jobs, according to the Bloomberg consensus. Average hourly earnings are seen holding near 3.7% year-on-year – still somewhat elevated for inflation to comfortably return to the 2% target – while the unemployment rate is expected to remain around 4.3%.
Given rising inflation risks, stronger data could trigger a positive market reaction, while weaker-than-expected figures could fuel stagflation concerns – rising unemployment alongside persistent inflation – and weigh on US equities ahead of the weekly close.
Beyond the Middle East headlines, one of yesterday’s most demoralizing developments was news that the US government plans to introduce a licensing requirement for certain advanced chip exports, forcing foreign companies to seek US government approval before acquiring these chips. The aim is to control the spread of advanced AI technologies and maintain the US technological edge. While understandable in the current geopolitical environment, it is not great news for Nvidia and AMD, which initially sold off before recovering some losses.
Overall, this week has injected a large dose of geopolitical uncertainty into a market environment that was already unsettled by concerns about Big Tech’s heavy AI spending – increasingly financed by debt – fears that AI could disrupt many business models and jobs, and growing stress in private credit markets.
The immediate market reaction was to buy US dollars and reverse the rotation trade from the US into Europe and Asia. Gold – traditionally both a safe haven and an inflation hedge – showed a surprisingly muted reaction to the rise in Middle East tensions, while defense and energy stocks outperformed as mining stocks gave back some gains, and airline companies got hammered.
Looking ahead, Middle East developments will likely remain in the headlines, though the initial surprise factor will gradually fade, meaning the knee-jerk reaction to headlines may become less pronounced. However, oil and energy prices will remain key in shaping inflation expectations and therefore central bank policy expectations, which in turn will drive global risk appetite.
As for oil prices, many analysts warn that crude could move toward the $100pb level if the conflict deepens. That is certainly a possibility. But the key question is not only how high prices rise, but how long they stay elevated. The longer energy prices remain high, the tighter global financial conditions become – and the weaker the appetite for risk assets.
