For those watching markets, oil will be the key transmission channel between the conflict and the financial world. At a bare minimum, the attacks in and around Israel and Gaza are likely to stop oil from dipping below current price levels, especially as investors watch to see if Iran is implicated. Iran exports around 1-1.5 million barrels of oil a day[1], not large by global standards but it has played in important role in filling the supply shortfall this year following production cuts by Saudi Arabia and Russia.
Yet the biggest question for the oil market is whether a rise in tensions could threaten tanker traffic through the Straits of Hormuz - daily worth around 20 per cent of global supplies[2].
“The market has acted very rationally so far,” said Fidelity International oil sector analyst and fund manager Paul Gooden. “It rose 3-4 per cent before steadying. That is a premium for the potential risks from the conflict rather than reflecting any direct hit to supply. For there to be another big spike it would take something like a direct threat to supplies through the Straits.”
Moves in oil bring with them the risk of another inflation shock, especially for oil importing countries. One comparison is the eruption of the Ukraine war last year. Iran’s situation and place in the oil production and export market is different to Russia’s, but much will depend on the attitude of other suppliers, most importantly Saudi Arabia.
“I do worry that compared to previous regional flashpoints, there may be more risk here,” said Salman Ahmed, Global Head of Macro and SAA. “Previous escalations of the conflict - the last serious one was in 2006 - usually were contained relatively quickly and ceasefires came into play after a few days of hostilities. But the world is a very different place now than it was in 2006.”
Changed playing field
The next steps of the crisis are critical: Israel’s response and what impact that has on the wider region.
“We have seen the first phase of the situation,” says Ahmed. “And now the second phase is starting in terms of its actions in Gaza directly. The third phase is how will the wider region respond.”
There have been efforts to broker better relations in the Middle East, both between Saudi Arabia and Iran and Saudi and Israel.
Gooden notes that the US, interested in keeping oil prices low in an election year, has gone easier on its sanctions regime towards Iran in recent months.
“If the US were to get tougher again on Iranian sanctions, that might tighten the market, but it would be a more gradual [price] rise,” he said.
Allocation
On the financial side, any boost to inflation brings with it the potential for a further extension of the ‘higher for longer’ stance that the big central banks have taken on interest rates and this will have an effect on expectations for the economy.
Financing conditions for companies and households are getting tighter and if there is another boost to prices globally it may also force the central banks to keep policy tighter for longer. Higher oil prices themselves will also act like a tax on consumption.
Our approach to asset allocation was already cautious and we were already forecasting a US recession in the coming 6-12 months, but the unfolding situation is clearly negative for risky assets in general.
For the short term, it has provided a safe-haven bid to the Treasury market after weeks of selling. We saw that in the Ukraine-Russia war last year as well: the immediate knee jerk reaction was a drop in yields. But they very quickly recovered and made new highs because the more long-lasting effect was on inflation.
We remain underweight both equities and credit and overweight government bonds. We believe that now is a time to stay flexible and, where possible, take regional, sector, and country specific views to adjust risk exposure, in particular moving to higher-quality market segments. We believe that the US dollar, gold, and government bonds should offer some protection if market volatility increases, although, again, the outlook for bonds is complicated by the potential for central banks to be compelled to remain more hawkish. We prefer UK Gilts and US inflation-linked Treasuries, and within credit we prefer the relative safety of investment grade over high yield.
For equities, we prefer exposure to the UK, emerging markets and Japan. A stronger US dollar is typically negative for emerging market equities and any rally is likely to exert pressure on the emerging market asset class. However, it is worth pointing out that emerging markets are less negatively exposed to a rising US dollar than in previous cycles such as the 2013 taper tantrum, with many economies holding less dollar-denominated debt than before.
An oil price rally would clearly have mixed implications for emerging market economies and companies based in the region, benefiting oil exporters and energy companies, but exacerbating inflationary pressures and negatively impacting energy importers and many consumer stocks.
[1] Iran’s oil exports hit 5-year highs as US holds nuclear talks | Reuters [2] Why This Narrow Strait Next to Iran Is So Critical to the World’s Oil Supply - The New York Times (nytimes.com)
Important Information
This document is for Investment Professionals only and should not be relied on by private investors.
This document is provided for information purposes only and is intended only for the person or entity to which it is sent. It must not be reproduced or circulated to any other party without prior permission of Fidelity.
This document does not constitute a distribution, an offer or solicitation to engage the investment management services of Fidelity, or an offer to buy or sell or the solicitation of any offer to buy or sell any securities in any jurisdiction or country where such distribution or offer is not authorised or would be contrary to local laws or regulations. Fidelity makes no representations that the contents are appropriate for use in all locations or that the transactions or services discussed are available or appropriate for sale or use in all jurisdictions or countries or by all investors or counterparties.
This communication is not directed at, and must not be acted on by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. In China, Fidelity China refers to FIL Fund Management (China) Company Limited. Investment involves risks. Business separation mechanism is conducted between Fidelity China and the shareholders. The shareholders do not directly participate in investment and operation of fund property. Past performance is not a reliable indicator of future results, nor the guarantee for the performance of the portfolio managed by Fidelity China. All persons and entities accessing the information do so on their own initiative and are responsible for compliance with applicable local laws and regulations and should consult their professional advisers.
Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities, but is included for the purposes of illustration only. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. The research and analysis used in this documentation is gathered by Fidelity for its use as an investment manager and may have already been acted upon for its own purposes. This material was created by Fidelity International.
Past performance is not a reliable indicator of future results.
This document may contain materials from third-parties which are supplied by companies that are not affiliated with any Fidelity entity (Third-Party Content). Fidelity has not been involved in the preparation, adoption or editing of such third-party materials and does not explicitly or implicitly endorse or approve such content.
Fidelity International refers to the group of companies which form the global investment management organization that provides products and services in designated jurisdictions outside of North America Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances.
Issued in Europe: Issued by FIL Investments International (FCA registered number 122170) a firm authorised and regulated by the Financial Conduct Authority, FIL (Luxembourg) S.A., authorised and supervised by the CSSF (Commission de Surveillance du Secteur Financier) and FIL Investment Switzerland AG. For German wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus. For German Institutional clients issued by FIL (Luxembourg) S.A., 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg.
Issued in France by FIL Gestion (authorised and supervised by the AMF, Autorité des Marchés Financiers) N°GP03-004, 21 Avenue Kléber, 75016 Paris.
In Hong Kong, this document is issued by FIL Investment Management (Hong Kong) Limited and it has not been reviewed by the Securities and Future Commission. FIL Investment Management (Singapore) Limited (Co. Reg. No: 199006300E) is the legal representative of Fidelity International in Singapore. FIL Asset Management (Korea) Limited is the legal representative of Fidelity International in Korea. In Taiwan, Independently operated by FIL Securities (Taiwan ) Limited, 11F, 68 Zhongxiao East Road., Section 5, Xinyi Dist., Taipei City, Taiwan 11065, R.O.C Customer Service Number: 0800-00-9911#2 .
Brunei, Indonesia, Malaysia, Philippines and Thailand: For information purposes only. Neither FIL Limited nor any member within the Fidelity Group is licensed to carry out fund management activities in Brunei, Indonesia, Malaysia, Thailand and Philippines.
Issued in Australia by Fidelity Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”). This material has not been prepared specifically for Australian investors and may contain information which is not prepared in accordance with Australian law.
ED23 - 214
