The financial markets should reflect the economic reality as closely as possible at any given point in time. However, this is a highly unemotional outlook that often runs into criticism, particularly when emotional events and footage hit the news. And while geopolitical strategists tell us that the impact of the recent escalations in the Middle East on the markets are likely to be limited, the markets have started to move as things could escalate if retaliation measures are so extreme that other involved parties have to step in.
Geopolitics: Eruption in the Middle East
Currently financial markets seem to be shifting into partial risk-off mode, with oil, gold, and the USD trading higher, while safe-haven government bonds could see a pause in yield increases. Top of mind is the risk of an escalation of the conflict towards Lebanon or Iran. Any escalation will determine how lasting the flight to safety on capital markets will be and if a broader impact on the economy is to be feared.
At least from a commodity perspective, geopolitics tends to be a temporary noise element rather than a lasting and impactful fundamental force. Our experts will monitor the current situation closely but believe that, for the time being, events will most likely follow the usual geopolitical playbook, with any escalation prolonging the duration and increasing the intensity of the shock. Further than just the Middle East, Chinese stocks continue to be dominated in the near term by global factors such as US rates and the fluid geopolitical situation.
Recovery in China is ongoing but fading
China’s National Day ‘golden week’ holiday traditionally leads to a strong increase in both Chinese domestic and outbound travel. This year, Chinese travel activity during the holiday periods has been watched particularly closely as a gauge of the consumption recovery following the reopening of the Chinese economy.
According to the Ministry of Culture and Tourism, during the eight day holiday this year, 826 million domestic trips were made and domestic tourism revenue reached RMB753 billion, thus increasing 4.1% above the pre-pandemic levels of 2019. That said, while the recovery in travel activity in China continues, it appears to be slowing. This is broadly in line with recent survey data for the services sector, which also showed a slowing of recovery momentum, following a sharp acceleration in the first few months after the reopening.
Global yields once again a volatile affair
Bond investors have experienced a roller coaster of emotions in the first week of the new quarter, mainly driven by signals from an overall resilient labour market in the US. The lower-than-expected wage growth number was not sufficient to keep yields from rising again, with the 10-year US Treasury yield around the 4.8% mark now.
US consumer price index data and the minutes of the Federal Open Market Committee meeting due later this week will provide the next impulse in a currently very volatile yield environment. However, current dynamics can mainly be explained by shifts in the real yield component, while inflation expectations remain stable.
What does this mean for investors?
While top of mind is the risk of an escalation of the conflict in the Middle East, some of the initial market reactions are already reversing and we encourage a wait and see approach.
However, those who believe in market timing could build positions in stocks over the next trading sessions, bearing in mind that a bottoming out of stock markets can be a bumpy experience. Alternatively, cash-rich investors could also use the ‘doom and gloom’ sentiment to get closer to their benchmarks.