For what length of time will oil prices stay high? Right now, that is a crucial question for international markets.
Virtually every major asset class has been stung by volatility over the past week as the combined U.S. and Israeli assault on Iran triggered one of the most rapid rises in crude-oil prices on record.
Strategists on Wall Street have been frantically simulating different market and global economic scenarios. The fact that the effects of geopolitical shocks are typically transient, at least in terms of financial markets, has already been extensively discussed.
However, Manish Kabra, head of Societe Generale’s U.S. equities strategy, claims that examining oil-price shocks (CL.1) (BRN00) during the previous 50 years can provide investors with some indications of what is most important for their portfolios at this time.
Based on these historical experiences, the most crucial question for international markets is: How long will the shock to oil prices last? How will other central banks, including the Federal Reserve, react?
The amount of suffering that markets may have to go through before President Donald Trump agrees to reduce U.S. military involvement could be a third corollary, though this is still quite unlikely. This evening, Trump will give a press conference from Doral, Florida. Earlier in the day, he reportedly stated to a CBS News reporter that he believed the battle was “pretty much complete.”
BCA strategists According to research, Trump may find it more challenging to change his mind this time around because Iran and Israel are also involved in the fight.In a written remark provided with MarketWatch, Kabra stated that two factors are crucial: 1) the duration of the shock; and 2) the Fed’s reaction function. Fed tightening “amplified the oil shock-driven recessions of the 1970s.” The final two shocks occurred during more robust expansion, whereas three of the five caused a recession in the United States.
Kabra concentrated his analysis on five prior events that caused oil prices to spike: the invasion of Ukraine by Russia in 2022, the start of the Iraq War in 2003, the Gulf War in 1990, the Iranian Revolution in 1979, and the embargo imposed by OPEC in reaction to the Yom Kippur War in 1973.
U.S. stocks typically beat their foreign counterparts during similar periods, according to historical data. Gold (GC00) and the US dollar (DXY) both often see increases. Below is a summary of the average performance of the key asset classes during the next week, three months, and six months.
Average return One week later Three months Six months Oil 9.90% 33.20% 30.90% Gold 2.00% 5.20% 22.60% Copper 2.30% 7.60% 6.90% USD (DXY) 0.20% 0.90% 1.50% US 10y -0.50% -0.30% -1.40% Global Equities -0.90% -2.70% -1.60% S&P 500 0.30% -2.70% 0.30% MSCI Europe -2.30% -2.50% -3.50% MSCI EM -4.10% -6.70% -1.00% Cyclical vs Defensive Sectors (US) 0.00% -6.80% -1.40%
Kabra went on to explain that, in the past, oil-price shocks have tended to dissipate after three months. But it isn’t the price move alone that matters to markets: How the Federal Reserve responds can also have a big impact.
Recently, traders of interest-rate futures have been betting that the jump in oil prices will make another Fed rate cut this year less likely, according to the CME Group’s FedWatch tool. Some are even betting that the Fed could raise interest rates if higher oil prices help to revive inflation.
So far, market-based gauges of investors’ inflation expectations over the long term haven’t moved all that much. That means the market still expects any impact on inflation to be relatively short-lived.
Kabra cited the five-year, five-year break-even inflation rate, which derives inflation expectations from trading in the market for U.S. government debt. The indicator measures investors’ expectations for the average rate of inflation during a five-year period beginning five years from now. It has been moving lower since the summer.
“Central banks will determine whether to look through temporary price spikes,” Kabra said.
U.S. stock futures tumbled overnight as stocks in Asia were hit hard, although European indexes fared better. By the time Monday’s closing bell rang in the U.S., major indexes had reversed their earlier losses and were trading higher.
The S&P 500 SPX, Dow Jones Industrial Average DJIA, Nasdaq Composite COMP and Russell 2000 RUT were all sitting on solid gains.
