Global investors received a stark reminder of how quickly the oil market can reignite concern about inflation and volatility, after U.S. President Donald Trump said on Wednesday that an interim agreement with Iran to end the war “is over.” Inflation-sensitive assets such as bonds and gold tumbled in the face of a 5-per-cent surge in oil.
Market Wake-Up Call
“It’s a big wake-up call for markets,” said Aneeka Gupta, director of macroeconomic research at Wisdomtree. The expectation had been “that we were likely to start to see the flow of oil coming back into the markets, and we saw inflation expectations being dialled down.”
Oil Prices React Sharply
Oil prices were inevitably the first to react to news from the Gulf and jumped as much as 6 per cent on Wednesday to a two-week high after Trump’s remarks. That said, Brent futures at close to US$78 a barrel are far from the US$100-and-above at which they traded for two months from mid-March, which had policy-makers’ inflation gauges flashing bright red. Prices had fallen rapidly after the U.S. and Iran signed an initial memorandum of understanding in June, reopening the Strait of Hormuz, as oil from tankers that had been stranded inside the Gulf hit the market, causing a mini-glut. The question is where prices will settle once the mini-glut passes. Will the latest developments make tankers less willing to re-enter the Gulf?
Stocks Face AI Doubts
The news hit at an inconvenient time for stocks. Some doubt is creeping into the AI story, as traders ask whether companies that have raked in billions of dollars for chips and AI models will keep doing so if supply bottlenecks ease, or if demand does not pan out as they expect. Since the Nasdaq’s record high on June 1, the makers of memory chips have been subject to a volatile downward correction. An ETF of memory chip shares has fallen nearly 8 per cent, while the Philadelphia semiconductor index is down 5 per cent. The world beyond AI has fared much better. The equal-weight S&P 500, which strips out the outsized impact of the largest stocks, has risen nearly 3 per cent, and Europe’s “AI-poor” STOXX 600 is up 4 per cent.
Bond Yields Surge
Bond yields jumped after Trump’s comments, taking their cue from oil prices, as traders raised their expectations of price increases and positioned for higher interest rates reversing recent weeks’ reduction in bets on hikes. Contracts tracking euro zone CPI inflation expectations in one year’s time rose 14 basis points (bps) to 1.992 per cent, and traders were last pricing in around 35 bps of further tightening this year from the European Central Bank, up from 25 bps on Tuesday. They saw 36 bps of tightening from the Federal Reserve, according to LSEG data on the Fed Funds market, and 32 bps from the Bank of England. Still, markets expect consumer inflation in the U.S. to be around just 2.15 per cent in a year’s time, down sharply from the 4.2 per cent figure recorded in May. Shorter-dated bonds, which are sensitive to interest rate expectations, were the biggest movers. Germany and Britain’s 2-year bond yields both jumped 10 bps to trade at their highest in just under a month. The reaction in the U.S., which is an energy exporter, was less dramatic with 2-year yields up 5 bps.
Volatility Wakes Up
Volatility had been largely absent for much of the past few months, but Wednesday’s news sent several measures higher. The VIX volatility index had been back to its prewar levels by early June, bar a brief spike on worries about high-flying tech stocks. A similar story can be told for volatility gauges for bonds and currencies – an almost unbroken decline over recent weeks, and a jump on Wednesday. The exceptions are equity indexes with heavy exposure to chips, such as South Korea or Taiwan, where volatility is stratospheric.
Gold Loses Its Shine
Gold is 23 per cent below where it was before the war broke out. Up to that point it had enjoyed a six-month run that lifted the price by 70 per cent as central banks, institutional investors and day traders all jumped on the bullion bandwagon. Having enjoyed a tentative rally since the start of July, gold is almost back where it started the month, trading down 1.1 per cent on the day at US$4,060 an ounce. The precious metal, generally regarded as a safe-haven asset and hedge against inflation, initially rose when the Iran war began, but turned sharply lower pretty much instantly. Instead of safe-haven demand, dollar strength and increased bets that central banks would hike rates dominated investors’ thinking, putting prices under pressure.
