The escalating conflict between Israel and Hamas challenges the appeal of US government bonds as a traditional safe haven.
Typically, geopolitical tensions drive short-term market moves towards safer assets like cash and US government bonds. However, on Wednesday, the yield on ten-year US government bonds increased by 0.07 percentage points to 4.9 percent, its highest since 2007. The 30-year bond yield also rose to 5 percent.
This surge followed the bombing of a Gaza hospital on Tuesday, which resulted in the tragic loss of 500 lives. Both Israel and Hamas have attributed the attack to the other, further complicating diplomatic efforts to de-escalate the ongoing war.
“Investors are showing hesitancy towards bonds due to an uncertain outlook regarding inflation,” Lyn Graham-Taylor, Rabobank’s interest rate strategist, noted. Tuesday’s stronger-than-expected US retail sales data also added to the bond market’s woes.
Global economic impact
“During the IMF and World Bank summit in Marrakech last week, the potential escalation in Israel was highlighted, indicating its significant impact on the global economy and world trade,” said Christofer Goovaerts, chief strategist at Bank Nagelmackers. “High oil prices are driving inflation, which in turn puts upward pressure on interest rates,” Goovaerts added.
Daleep Singh, PGIM’s chief economist and a former adviser to Joe Biden, agrees. If the Israel-Hamas conflict spreads beyond Israel, major economies could witness a sharp increase in interest rate curves. Singh estimates the current likelihood of further escalation in the Middle East at 45 percent, which, according to PGIM’s calculations, could cause a 15 to 20 percent surge in oil prices.
Singh, however, remains optimistic that enough global incentives exist to avoid a full-blown spiral of violence. If the conflict remains contained within Gaza, he predicts a moderate 5 percent rise in oil prices without a lasting market risk sentiment.
As of Wednesday, Brent Crude, the international oil standard, traded around 91 dollars a barrel. While this is below its late-September peak of 94 dollars, it’s over six percent up from the previous week. Gold, another popular safe-haven asset, is trading at 1960 dollars a troy ounce, an eight percent rise since the conflict’s onset.
Potential for equity decline
Economist Jan Longeval, a professor at Vlerick Business School, believes the market may be underestimating a potential pre-emptive strike by Israel on Iran’s nuclear facilities.
“Hamas and Hezbollah seem to have received support from Tehran for their attacks. An Israeli offensive could drastically escalate regional tensions,” Longeval commented, adding that war has historically been associated with spikes in inflation.
Such an escalation, Longeval predicts, would lead to higher risk premiums in equity markets. “Equity prices, particularly in emerging markets, are expected to drop, while traditional safe havens like gold, the Swiss franc, and the Japanese yen will see increased demand.”
Lastly, a Bank of America survey of investors conducted from 6 to 12 October revealed a notable shift. Over the past month, there’s been an uptick in energy and commodities investments. Furthermore, 23 percent of surveyed managers identified worsening geopolitics as the most significant threat to global growth.