Tensions in Middle East to test markets, ahead of week dominated by central bank news

Middle East tensions to test market sentiment

The week will begin on a slightly nervous note this morning. Geopolitical tensions in the Middle East looks as though as they’ve inflamed further, following the (alleged) Iranian-backed attack on a key oil facility in Saudi Arabia. Naturally, the eye will move straight to the oil price to judge the attack’s material impacts. One assumes we’ll see a pop in oil prices early today, as the major disruption to global production and supply is priced-in. But the greater curiosity will be in whether this event leads a significant lift in volatility in broader markets, given the heightened risk of war in the Middle East.

Searching for the next Black Swan

This is where the things get quite interesting. What’s the risk of a violent turn in global geopolitics? What would the impact be to the global economy if such a thing were to occur? It appears that, when compared to economics and monetary policy, at least up to this point, the multitude of international political ructions have been considered of tertiary importance by market participants. This could prove, in time, to be very naïve. Markets are no doubt looking for the big risk to catalyse the next recession. Their attention, however, has been preoccupied with trade-wars and central banks. Perhaps a major military conflict is this generations’ circling “Black Swan”.

Is a ‘negative supply shock’ the greatest risk to markets?

It’s not a fringe idea, by any means, that the most significant risk to global markets is a highly disruptive war. Esteemed economist Nouriel Roubini recently suggested as much. A “negative supply shock” brought about by a conflagration in any one of the many geopolitical conflicts across the globe makes it “easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system”. Such an event would be potentially disastrous to a global economy already slowing down – and worse still, its consequences would likely be resistant to any fiscal and monetary stimulus plied by policymakers.

Markets caught in the tides of political change

A dour way to begin the week. And it must be said that the base case in markets isn’t for a devastating human conflict somewhere on the planet. But it’s still worth noting, because for the first time, presumably, since the cold war, the status quo in global markets is being shaken-up. And judging by how global leaders are responding to this dynamic, there is some degree of scepticism that the disruption can be appropriately managed. These are novel problems, in a way, after all. And as Marshall McLuhan said, when it comes to profound change, politics: “offers yesterday's answers to today's questions.”

Politics and monetary policy to dominate news-flow

So, with the trade-war, Brexit and now greater tensions in the middle east, politics could drive the narrative in markets to begin the week. It adds to the plate of major news stories before market participants in the next 5-days. Domestically and abroad, the fundamentals of the week’s trade will be centred around central bank policy making. After the ECB’s perplexing meeting last week, attention turns now to the US Fed, Bank of Japan, Bank of England, and Swiss National Bank, which all meet this week. At home, the RBA’s minutes from its last meeting are released, before all-important jobs data is published on Thursday.

Event risk likely to keep bullish impulses subdued

This plethora of event-risk, and the swirling of fast-moving information in financial markets currently, could keep risk-appetite subdued to begin the week. In the face of uncertainty, keeping the chips off the table will probably be the broad approach from market participants. This comes despite what was actually quite a reasonable conclusion to last week’s trade. Stocks finished the week quite flat. However, the data received was at least a little heartening. The focus was on the US consumer. Retail Sales and Consumer Sentiment figures were printed, and on balance, delivered solid-enough readings, easing very marginally some level of concern about the risk of an imminent US recession.

Price action points to improved fundamental outlook

Of course, good economic data, in the short-term, does little for liquidity hungry stock markets, so Wall Street closed practically flat, and that’s setting up the ASX 200 for a marginally negative start today, according to SPI Futures. But the better barometers of global economic health are showing signs of marginally better sentiment. Bond yields continued to edge higher on Friday, pushing gold prices down further below $1500. The Japanese Yen is still falling, too. The VIX is making a foray into the 13 mark, showing investors are primed for risk-taking, provided some free air. This is not discounting, of course, the attack over the weekend in Saudi Arabia.