Executive summary:
- One key potential economic implication of the tragedy in the Middle East is a disruption in oil supply
- U.S. consumer prices rose slightly higher than anticipated in September
- The Fed will likely keep rates on hold at its next meeting
On the latest edition of Market Week in Review, Portfolio Manager Olga Bezrokov and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed the Israel-Gaza war as well as the latest U.S. inflation numbers.
What are the potential economic impacts of the Israel-Gaza conflict?
Antal-Gilbert and Bezrokov began the conversation by expressing their deepest sorrow for all individuals impacted, whether directly or indirectly, by the ongoing tragedy in the Middle East. Antal-Gilbert then asked Bezrokov what the potential implications of the Israel-Gaza war could be for the global economy and markets.
The main economic risk is through oil markets, Bezrokov responded, explaining that if the conflict escalates and broadens out in the Middle East, there could be disruptions to the global oil supply. The market’s initial reaction to the crisis certainly demonstrated awareness of this risk, she remarked, noting that U.S. Treasury yields fell at the start of the week of Oct. 9 as investors flocked to the safety of government bonds.
However, as of market close on Oct. 12, Treasury yields had mostly risen back to the levels they were at before the conflict began, she observed. The same also largely held true for equity markets, Bezrokov noted, with stocks falling at the beginning of the week before staging a rebound. Oil prices, too, had largely retreated back to where they were in early October after spiking on Oct. 9, she said.
Next, Bezrokov discussed how prior periods of conflict in the Middle East have impacted oil markets. “A glance at recent history shows that there have been some significantly—but increasingly shorter-lived—periods of volatility in energy markets,” she said, noting that her analysis includes the Arab-Israeli War of 1973 and the first Gulf War in the early 1990s.
However, the nature and immediate impacts of the ongoing Israel-Gaza war differ from other past conflicts, Bezrokov stressed. Just as importantly, the global oil supply has changed dramatically over the past 50 years, she said, with the U.S. economy in particular not as sensitive to energy shocks as it once was.
“Overall, at Russell Investments, our view is that the impact to markets from this war is likely to be modest and transitory. However, this is very much an evolving situation that we’ll need to closely monitor in the coming weeks,” Bezrokov stated.
She added that Russell Investments has not made any immediate changes to its portfolio positioning in response to the current conflict. “Our portfolios are generally running at a balanced or slightly cautious risk posture, which we believe is appropriate. We have very little direct exposure to Israel in our portfolios, and our active exposure to the energy sector within equities is small. We are watching interest rate markets particularly carefully. If we were to see a sharp decline in Treasury yields, we might look to that as an opportunity to moderate the interest rate sensitivity in our fixed income and multi asset portfolios,” Bezrokov explained.
U.S. consumer price gains top expectations
Turning to the latest U.S. inflation numbers, Bezrokov said that both producer price index (PPI) and consumer price index (CPI) data for September were recently released. In a nutshell, both reports came in a touch above consensus expectations, she said, highlighting that ongoing cost pressures continue to impact the U.S. economy.
The PPI rose 0.5% during September as gasoline prices drove goods prices higher, Bezrokov noted. Meanwhile, the CPI climbed by 3.7% last month on a year-over-year basis, she said—slightly higher than the 3.6% gain that was anticipated. “A fair amount of this increase was due to a lesser-than-expected decline in energy prices,” Bezrokov stated, noting this demonstrates the impact energy markets can have on inflation in the U.S. and around the world.
On a more positive note, she said that inflationary pressures across categories like food, new vehicles, shelter and transportation services continued to slow last month. In addition, prices for used cars and trucks also declined, Bezrokov remarked.
That said, inflation still remains well above the Fed’s target rate of 2%, she noted. However, Bezrokov said she expects the U.S. central bank will keep interest rates unchanged at its Oct. 31-Nov.1 meeting. “Over the past few weeks, a common theme we’ve seen emerge from the remarks of several FOMC (Federal Open Market Committee) members is that the Fed is sensitive to the sharp rise in long-term Treasury yields,” she stated, explaining that the central bank views the increase as another form of financial tightening.
Ultimately, in the long term, this could mean the Fed might not need to keep rates high for as long as markets expect, while in the short term, it likely means the Fed will stay on pause in November, Bezrokov concluded.
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