Middle East conflict escalates: risk aversion is on the rise, gold may have a fantasy trip

國君海外宏觀研究 ·  Apr 14 16:33

Source: Guojun Overseas Macro Research
Author: Zhou Hao

The conflict between Iraq and Israel escalated when Iran launched its first direct attack on Israel in history on April 13. Geopolitical risks, along with inflationary pressure, are beginning to suppress global risk aversion, and the stock market may be one of the earliest victims.

For the stock market, the fluctuations will still be short-term. As far as US stocks are concerned, there is pressure to adjust themselves. After short-term adjustments, the market will still focus on the performance of financial reports.

In the short term, it seems difficult for the market to find better alternatives to safe-haven assets, which also means that gold, dollars, and bonds will gain momentum in the short term. Crude oil prices also seem prone to falling due to the Middle East conflict. Inflationary pressure brought about by rising crude oil prices means that expectations of US interest rate cuts may be further suppressed.

As far as US bonds are concerned, risk aversion may drive capital inflows, but inflationary pressure is very prominent due to high oil prices, so a sharp decline in interest rates may not be the benchmark situation. Short-term interest rates remain high, and long-term interest rates are being lowered due to disturbances in growth prospects. This may be a probable event.

For the US dollar, further upside should be expected. Judging from the spread between US bonds and European bonds, interest rates on US bonds have been rising faster recently, which means that from the perspective of interest spreads alone, the US dollar seems to have stronger momentum. Of course, from the perspective of capital flow, due to geopolitical factors, some overseas funds may reduce the allocation to US bonds, and the probability that these funds will flow to gold and other types is even greater.

01 The conflict between Iraq and Israel escalates

Iran launched its first direct military attack against Israel on Saturday (April 13). The Israeli military said Iran fired more than 100 bomb-carrying drones at Israel. A few hours later, Iran announced that it had also launched more destructive ballistic missiles.

On April 1, 2024, the consular building of the Iranian Embassy in Syria was hit by a missile attack, killing at least 13 people. Iran and Syria believe the attack was initiated by Israel, and Iran's leaders insisted on launching a retaliatory strike.

US National Security Council spokesman Adrienne Watson (Adrienne Watson) said on Saturday that the US “will stand with the people of Israel and support them in fighting these threats from Iran.” US National Security Adviser Jake Sullivan (Jake Sullivan) also spoke with the Israeli Defense Secretary to reinforce Washington's “firm commitment” to Israel's security.

02 Risk aversion is on the rise

As the conflict between Iran and Israel escalated, the focus of the market was once again shifting to the Middle East. Obviously, the instability of the situation in the Middle East is a concrete sign of the intensification of geopolitical conflicts. Combined with Japanese Prime Minister Fumio Kishida's recent speech in the US, the market's interest in geopolitics has risen markedly, and it is priced in its own investment model. This is inevitable, and it is also a long-term trend.

As far as capital markets are concerned, the direction of the conflict between Iraq and Israel will suppress the market's risk appetite in the short term. Although the market has different interpretations and prospects of the conflict itself, the incident of rashy pricing will soon subside, and it seems that it will also make many investors uneasy.

Over the past period, the prices of gold and crude oil have risen markedly. The outbreak of a new round of conflict in the Middle East seems to keep commodity and precious metal prices supported for some time. Gold's trend was very turbulent on Friday. After hitting a record high of $2,430, the price of gold suddenly plummeted and closed at just $2,344 per ounce.

Large market fluctuations themselves mean that sentiment is easily amplified, and the trend of the Middle East conflict is still unclear, which also means that the fantasy journey of gold is still ongoing.

03 Flattening the US Treasury Interest Rate Curve

The escalation of the Middle East conflict is clearly putting further pressure on America's inflation prospects. But at the same time, rising risk aversion will also cause capital to flow into bond assets. Therefore, the impact of the conflict between Iraq and Israel on US bond interest rates is complicated. Our bold guess is that interest rates on short-term US bonds will be affected by factors such as inflation and delays in interest rate cuts, while interest rates on long-term US bonds may be “suppressed” to a certain extent due to risk aversion and rising inflation suppressing long-term growth expectations. In other words, the interest rate curve will flatten to a certain extent.

$04 could be stronger

The trend of the US dollar has been very strong recently. The rise in risk aversion may bring about a new round of upward trend in the US dollar, which will generally suppress the sentiment of US stocks. At the same time, we will also find an interesting phenomenon. The interest rate spread between US bonds and European bonds has begun to rise markedly in the past few weeks, which means that the market began to cut US interest rates even later and cut interest rates in the Eurozone earlier. At the same time, in comparison, the performance of European bonds is more stable, probably considering that overseas capital will sell off US bonds to a corresponding greater extent.

From this perspective, the widening spread between US bonds and European bonds means that, at least in the short term, the probability that the US dollar will strengthen against the euro will also start to increase. From the level predicted by interest spreads, the euro exchange rate may fall below 1.05.


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