The Week Ahead: Geopolitical risks push the oil price higher It’s a shaky start to the week for financial markets. The oil price has risen by nearly 4% and Brent crude is trading above $79 per barrel. This comes after more attacks between the US and Iran in the Gulf, and statements from the Iranian regime that it has closed the Strait of Hormuz. The US is disputing this claim, but commercial traffic has slowed through the Strait once more, which is adding to the negative sentiment seen in financial markets today.
Will the oil price move higher?
This week will be a test to see if the continued skirmishes between the US and Iran can be absorbed by financial markets without causing major damage. The oil price remains below $80 per barrel for now, and the prevailing view is that the current situation will not evolve into another full-scale war, even if President Trump believes that the ceasefire is over. Thus, for now, oil price gains remain contained, and the price of Brent crude has not risen above $80 per barrel.
South Korean Kospi stays volatile
Stocks were sharply lower in Asia overnight, and the Nikkei fell about 2%. The South Korean Kospi plunged 9%, proving that it is one of the most volatile indices out there. This comes after SK Hynix, which listed on the Nasdaq last Friday, fell 15% overnight, eroding the gains made at the end of last week and experiencing its worst day ever. The South Korean listed stock price is down 19% in the past month, however, the sell off should prove to be temporary. There is huge structural demand for chips and memory, and this could be reinforced this earrings season, with high expectations for capex spending from the major hyperscalers to remain elevated into next year. Thus, any sell-off could be seen as a buying opportunity.
Momentum trade gets reality check
US futures are pointing to a lower open later today, led by the Nasdaq, which is forecast to decline more than 1%. The Dow Jones is expected to see the mildest sell off, with futures only predicting a 0.3% decline at this time. This suggests that the rise in geopolitical tensions and the spike in the oil price are disrupting the momentum trade once again, which will hit the tech trade and the chip stock rally. The reaction in the Kospi, which is dominated by chip stocks, could be replicated in a less volatile fashion elsewhere.
Why are chip stocks selling off?
The question is, why do geopolitical risks hit chip stocks and tech stocks more than other sectors of the market, even though the chip sector is more insulated from the chaos of the war? There are a couple of reasons for this: 1, the chip trade is big in the retail community, especially in Asia, who also have access to leveraged ETFs, thus when the external environment changes, some of these retail traders may take fright. If they have leveraged positions, this can magnify the sell-off. 2, when geopolitical tensions rise, it can lead to risk aversion and increase demand for physical assets including cash. This leads to some cutting of the most profitable trades, which are South Korean equities and global chip stocks so far this year. The South Korean market is now considered a key barometer of sentiment towards the chip sector, so when it declines it can have ripple effects across the world. With geopolitical risks rising once more, the focus for investors will be earnings season. Analysts remain upbeat on the earnings outlook, which could be why US stocks managed to eke out gains last week, even though President Trump said on Wednesday that the ceasefire was over with Iran.
US still managing to outperform
US indices outperformed their European and Asian counterparts last week. The S&P 500 rose more than 1%, the Nasdaq eked out a 0.9% gain, and the Dow Jones rose 0.4%. This compares with a 1.4% decline in the FTSE 100 last week, and a 1.6% drop in the Eurostoxx 50 index. If US tech stocks sell off sharply today, we could see European indices try and claw back some recent losses, however, over the past month, Europe has been a laggard compared to Asian and US indices, and this may continue as we move through earnings season.
The economic outlook
Overall, the economic data front is proving supportive, US ISM surveys showed a resilient service sector, as tech spending continues to boost economic activity. Added to this, the latest initial jobless claims suggest that the labour market remains solid, even though last month’s payrolls report was weak. In Europe, there were encouraging signs from Germany that its manufacturing sector is getting back on its feet after a long period of decline. In China, CPI is running in the opposite direction from the West and came in lower than expected at 1% YoY.
Andy Burnham to feel the strain from rising oil prices
In the UK, Andy Burnham is expected to be made leader of the Labour Party at the end of this week, before becoming PM next week. He faces a huge set of challenges and is attempting to put together a ‘mega’ budget in the next three months to lay out his plans for tax and spending by October. This means two things, he will likely keep quiet about his economic plans over the summer months, which could backfire on him and lead to wild speculation, secondly, expect a summer of horse trading, as Labour MPs clamor to get a slice of Burnham’s pie. The problem for Burnham remains the UK’s debt costs. Bond yields rose again last week, the 10-year Gilt yield was 12 bps higher.
Although this was in line with gains in yields across Europe, it is a keen reminder that UK bonds are sensitive to oil prices, and any extra borrowing from Burnham will come at a high price. We will be watching bonds and the pound in the coming days, to see if Burnham’s coronation causes any fluctuations in UK asset prices. As trading gets started this morning, bond yields are ticking higher and the gold price is also lower as the dollar catches a bid. This is another reminder that traditional safe havens, like government bonds and gold, offer no protection when geopolitical risks threaten inflation. Thus, if we see continued escalation in the conflict, and the oil price rises back towards $90, we will likely see a deeper selloff in sovereign bonds and in the gold price.
Events to watch this week
Geopolitical risks combine with monetary policy risks this week, as Kevin Warsh, the new
