Market Narratives Diverge As Commodity Shock Triggers Broad De-Risking

As geopolitical news flow continues to dominate the agenda, and remains at the forefront of participants’ minds, a couple of interesting divergences are beginning to make themselves known.

Firstly, from the perspective of price action, we see a couple of distinct themes.

Unsurprisingly, there is a flight to quality, and havens, taking place. Not only has this underpinned gold to a degree, though gains have been trimmed in recent sessions, but more obviously this has triggered substantial inflows into the greenback. This, as if it were ever in doubt, proves that in times of real strife, the greenback is still Mr Market’s haven of choice, and remains the ‘cleanest dirty shirt’ in the FX world.

As participants batten down the hatches, trimming exposure to equities as well, the other dynamic that is increasingly coming through is that of a commodity price shock.

Clearly, crude benchmarks have rallied sharply as participants have priced a greater risk premium since the conflict begun, but nat gas prices have surged too, largely as a result of Qatar suspending LNG production. In turn, this has led markets to price a tighter near-term monetary policy backdrop, with STIRs repricing hawkishly across DM, and has also led to a sell-off for Govvies across the board. Along with this, the currencies of large energy importers – i.e. those countries which would be most exposed to such a shock – have underperformed, with the GBP, EUR, and JPY facing notable headwinds in recent sessions.

Concurrently, while participants attempt to wrap their heads around those two dynamics, there appears to be a significant difference in how developments are being interpreted across the globe.

Here in Europe, and in APAC too, judging by not only the price action but also conversations with participants, the general view is one of seeking to de-risk as much as possible, with focus almost squarely on the left-tail risks posed by a prolonged conflict, or an escalation in wider Middle East tensions, particularly in terms of the inflationary implications, and growth headwinds, that a surge in energy prices would trigger.

Across the pond, however, the view appears different. Stateside, consensus seems to have formed more around military action being relatively short-lived, and surgical in nature, with there even being the possibility for this to pan out as a longer-run net positive, if geopolitical risk in the Middle East is materially reduced as a result of the present military intervention.

To be clear, right now, it is far too early to definitively say which side of the proverbial coin markets will come down on, as the dust settles. I would reiterate, however, that despite some monumental moves in energy prices, and substantial volatility elsewhere, geopolitical events are typically short-term shocks for markets to digest, and not longer-run triggers for a change in the broader narrative.

Recent price action – for instance, with precious metals rolling over sharply, STIRs pricing a 50% chance of an ECB hike this year, and even the defensive-heavy FTSE 100 sinking over 3% intraday – suggests that we may be at, or getting close to, an extreme from a sentiment perspective.