How Investors Are Navigating Geopolitical Challenges – Reuters

By Dhara Ranasinghe and Alun John

LONDON – Tensions in the Middle East are on the rise again, yet financial markets appear to be maintaining a positive outlook, influenced more by changes in oil production and anticipated global interest rate reductions than by geopolitical issues.

Israel continues its conflict with Hamas in Gaza and has launched attacks on Beirut, intensifying its clash with Hezbollah in the wake of recent Iranian provocations.

Despite this turmoil, MSCI’s world stock index is only 1% away from last week’s record peaks, and oil prices, which surged about 5% following Iran’s missile attack on Israel, have stabilized around a manageable $75 a barrel.

While a significant escalation that disrupts oil supplies from the Middle East and impacts the global economy would likely provoke a stronger market response, the current near-record stock prices could expose them to sharper declines. For now, however, markets are buoyed by the prospect of monetary easing and an increased U.S. role in oil production, which has mitigated the Middle East’s traditional influence over supply.

The volatility index, often referred to as Wall Street’s "fear gauge," remains at a moderate level near 20, significantly lower than the post-pandemic peak of over 60 seen during the early August turmoil linked to unwinding global carry trades.

Mark Dowding, chief investment officer at BlueBay Asset Management, noted, "The geopolitical risks affecting asset prices will have a much larger impact if they lead to significant changes in growth or inflation." He acknowledged that concerns have primarily concentrated on oil prices, but indicated that these have recently shown a downward trend.

Analysts point out that the United States, as a major oil producer for the past six years, has lessened global vulnerability to supply disruptions from the Middle East. Moreover, European energy markets have adapted since Russia’s invasion of Ukraine, showcasing the market’s sensitivity to energy price fluctuations.

"The increasing importance of the U.S. suggests that risks to energy supply arising from heightened tensions in the Middle East are somewhat lessened," remarked Katharine Neiss, chief European economist at PGIM Fixed Income.

Compared to 2022—when Russia’s invasion of Ukraine sent oil prices soaring above $100 and triggered a fresh wave of inflation—the current environment is markedly different. Central banks are already adopting easing measures, and there’s hope that the U.S. economy will sidestep a recession.

According to Trevor Greetham, head of multi-asset at Royal London Asset Management, the global economy is not positioned for an oil shock at this time, as it is in a "softer stage of the cycle."

This situation contrasts with the sharp inflationary pressures experienced during the 2022 crisis. The current context, characterized by more accommodating monetary policies, continues to bolster investor confidence, even amid rising tensions in the Middle East.

Tilmann Kolb, an emerging markets strategist at UBS Global Wealth Management, emphasized that, despite notable developments in both domestic and international politics over the past two years, the economic outlook remains the focus for markets. He raised key questions about inflation, the Federal Reserve’s response, and the sustainability of economic growth.

Investors are also reacting positively to the announcement of long-awaited economic stimulus measures from China, which has led to a surge in Chinese stocks and boosted global asset prices spanning luxury goods and industrial commodities.

"The impact of China’s significant policy stimulus last week has been a critical factor for global demand and growth," stated Dowding.

However, the situation could shift rapidly, and oil remains a pivotal factor should geopolitical tensions escalate. Tina Fordham, founder and geopolitical strategist at Fordham Global Foresight, is closely monitoring whether Israel will target Iran’s energy infrastructure or nuclear facilities, noting that either scenario could influence markets considerably.

She also pointed out the potential complications if Ukraine were to target Russian energy infrastructure simultaneously.

With stock markets nearing record highs, analysts caution that significant declines could be imminent, especially as geopolitical risks grow. The Bank of England recently indicated that global asset prices are stretched and that increasing concerns about geopolitical instability could lead to considerable market corrections.

Andrew Bresler, CEO at Saxo UK, added that assets are mispriced in light of prevailing geopolitical risks, arguing that volatility indicators should reflect greater caution. "It’s concerning how desensitized the markets seem to these geopolitical threats," he remarked.