Israel Halts Operations in Gaza as Markets React to Recent Conflict
After Hamas’ incursion into Israel on October 7th, global markets experienced a jolt, causing an oil surge and heightened concerns about a wider regional conflict. However, recent developments, including Israel’s agreement to pause operations in northern Gaza for four hours a day, have helped to ease fears and stabilize global stocks.
Although oil prices are currently below pre-conflict levels, derivatives markets tell a different story. Bets on oil prices moving up are at their highest level since Russia’s invasion of Ukraine in 2022. This trend is reflected in the average daily volumes in energy options, which are the highest since an all-time record in 2018. It seems that investors are more concerned about the potential for a rise in oil prices rather than a decline.
Gold prices have dropped over $50 an ounce after reaching $2,000 last week. Signs that the conflict is contained have positively impacted Israel’s bonds, as well as those of neighboring countries Jordan and Egypt, which have recovered from post-attack falls. However, credit default swaps (CDS) for Israel express more pessimism, with the pricing of these instruments matching that typically paid to insure against default by a country on the verge of being downgraded to a junk credit rating. It is important to note that Israel’s AA-rating is six notches above what CDS pricing implies, suggesting potential market overreaction.
The defense sector has experienced an 8% increase in the four weeks since the conflict began, making it one of the few sectors to outperform global stocks. While this sector could potentially fall out of favor if hostilities cease, it is still viewed as a long-term winner, particularly due to increased defense spending. Portfolio managers at Amati Global Investors and Lazard Asset Management have expressed confidence in defense and security stocks, with plans to back innovative companies in the industry.
The Swiss franc has emerged as the best performing major currency against the dollar since October 7th. It is also near eight-year highs versus the euro, attracting questions about its performance if Middle East tensions are resolved. The Swiss central bank’s decision to sell foreign currency reserves to reduce its balance sheet has provided support for the Swiss franc. However, experts caution that the currency is currently expensive from a longer-term perspective.
If the conflict escalates, the euro’s performance against the dollar will be worth watching. The flight to safety bid typically benefits the dollar, while the euro area, as an energy-importing region, may face challenges if oil prices rise again.
Corporate bonds, particularly in Europe, could face further challenges if oil prices increase. Europe heavily relies on energy imports, and a rise in oil prices could impact the perceived riskiness of European junk debt.
Overall, the situation in the Middle East continues to impact global markets. While recent developments have helped calm fears, investors remain cautious about the potential for escalation. The market’s focus is shifting towards oil prices, defense stocks, and currencies, as these assets reflect ongoing concerns and potential future developments.
More detail via Reuters here… ( Image via Reuters )