It’s a mixed morning across Europe with the FTSE 100 down 0.5 per cent but shares in Frankfurt and Paris up around 0.7 and 0.5 per cent respectively. Domestic shares are down as weaker crude oil prices hit the likes of Shell and BP, with the pair wiping 20 points of the index. Rising risks in the Middle East are affecting the oil price this morning with all eyes on whether Israel responds. The oil hit comes after Wall Street closed down quite hard on Friday, with the S&P 500 dropping almost 1.5 per cent to cap the worst week of 2024. There was a definite risk-off sentiment move on Friday, but this is rebounding a touch this morning with futures a bit firmer.
The situation in the Middle East is proving tricky for markets. Everything has been going up lately – stocks, Bitcoin and gold are all at record highs. But what impact is the burgeoning conflict having on day-to-day risk sentiment?
Oil spiked higher on Friday but dropped in the wake of the Iranian attack on Israel – you could say that the attack was big, but Tehran seems to be saying the matter is now closed. Gold also raced higher Friday morning before reverse-ferreting in the afternoon and holding losses this morning. US yields are firmer but there has been a geopolitical premium to gold ever since 7 October. Bitcoin dived on the attacks – it fell 14 per cent from its Friday afternoon level before paring losses after Hong Kong approved a spot ETF. The real flight to safety has been to the dollar – DXY futures highest since mid-November – but that’s probably more to do with higher Treasury yields and the emergence of monetary policy divergence among the major central banks.
Where does the conflict go from here? Does it push oil up further? An escalating conflict would add a premium for near-dated crude futures. Gold is harder to fathom as it has decoupled from real yields such as the 10-year Treasury Inflation-Protected Securities (Tips). But what about the debt-debasement trade? Right now the Israel situation is on the margins of the bigger stuff such as the macroeconomic outlook, the Federal Reserve and earnings. But what if it does escalate?
Last week we started to see central banks diverge – US inflation saw markets sharply price out a June cut, while the European Central Bank said it would start to ease. But the question I want to ask is really whether we are in an era of fiscal dominance. Will the fiscal taps continue to prevent central banks from taming inflation, and do they care? This has a lot of implications for markets and in particular for our assessment of whether the Fed and ECB are starting to part ways.
Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low. With the US adding about $1tn in debt every 100 days, it’s hard to see how the Fed can tame inflation properly. Tacit acceptance of higher inflation is the price of financing everything from foreign wars to ‘domestic bliss’. Longer term that is going to be the case for Europe too. In the short-term at least, markets see divergence.
Meanwhile, keep an eye on Tesla shares with reports the company could be about to announce major layoffs. This is not a good story for a stock already 30 per cent down year to date. Later today we have US retail sales figures and the Empire State manufacturing index.
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The Trader is written by Neil Wilson, chief market analyst at Finalto
