Market Flash: Middle East Conflict Continues to Escalate

Market volatility had begun to ease over the last few days, but tensions escalated again following attacks on Iranian and Qatari gas infrastructure on Wednesday and Thursday. Of particular concern to investors were the strikes on Qatar’s Ras Laffan complex, given it is responsible for roughly 20% of global Liquified Natural Gas (LNG) output.

This marks a material shift in the nature of the disruption. Until now, the conflict had mostly impaired transportation routes, particularly shipping through the Strait of Hormuz, but direct attacks on production facilities significantly raise the risk of more persistent energy shortages.

The recent strikes have also reinforced the perception among investors that President Trump is struggling to control events. The US has been especially keen to avoid damage to energy infrastructure, fearing the impact on energy prices.

What has been the latest market response? – to 19th March close

• UK and European equity markets fell over 2% on Thursday following the sharp rise in gas prices, which will be felt acutely across Europe.
• However, the US equity market continues to outperform, down only 0.3% on Thursday. This continues to reflect its greater energy independence.
• Government bond yields continued to rise (bond prices fall as yields rise) as investors continued to reassess the inflationary outlook and what this may mean for interest rates (more on this below).
• A widening divergence between the US oil benchmark, WTI, and the global benchmark, Brent, has emerged, with WTI trading around a $15 discount. This may partly reflect the US release of Strategic Petroleum Reserves, but markets are also beginning to price a non negligible probability of an American oil export restriction. This would help to contain prices in the US but increase pressure on prices globally.

What are central bankers doing?

This week we also heard from central bankers for the first time since the start of the conflict. The Bank of England (BoE), who before the conflict were expected to cut this month, held interest rates at their meeting on Thursday. This gives the Monetary Policy Committee (MPC) time to assess the medium-term inflationary impact of the Middle East conflict. With a further uptick in inflation likely in July, when the new energy price cap comes into effect, it’s now unlikely that the MPC will decide to cut before the end of the summer.

That said, the MPC’s messaging is important. In principle, one-off supply-driven energy shocks are something central banks should “look through”, as they have no control over it. But coming so soon after a period of elevated inflation, and with inflation already above the BoE’s 2% target, there is a risk that renewed price pressures could feed into higher inflation expectations. They seem very attentive to this risk, justifying the MPC’s more cautious stance. 

Looking ahead, the debate over the MPC’s next move has become more finely balanced, especially given Thursday’s energy market reaction. We don’t think we are in hiking territory yet, but if oil and gas prices remain elevated and the shock proves persistent, then we could see inflation reach 4-5%. At this level, the MPC may feel compelled to hike to prevent longer-lasting inflation persistence.

Summary

Market volatility remains high, across most asset classes. We remain comfortable with our portfolios, continuing to take particular comfort from the diversification achieved via our infrastructure holding and from our regional equity positioning. That said, we remain vigilant to these risks and continue to monitor the performance of our portfolios and underlying funds on a daily basis.

Risk warning 
This article is for intermediaries to be used for information purposes only. It does not constitute an offer or solicitation to invest, it is not advice or a personal recommendation nor does it take into account the particular investment objectives, financial situation or needs of individual clients. Whilst HRIS uses reasonable efforts to obtain information from sources which it believes to be reliable, HRIS makes no representation that the information in this document is accurate, reliable or complete. 

The value of your investments and the income from them may go down as well as up and neither is guaranteed. Investors could get back less than they invested. Past performance is not a reliable indicator of future results. Changes in exchange rates and/or tax rates may have an adverse effect on the value of an investment.