Israeli/Palestinian conflict
The second geopolitical conflict which has been in the spotlight lately has been the renewed clash between Hamas fighters in Gaza and Israeli forces. Over the weekend, the death toll increased significantly as a ground incursion was initiated by the Israeli army. So far, several attempts to reach a ceasefire have failed as both sides continue to hold to their stance.
In terms of global implications, involvement of another Middle-Eastern country would clearly intensify this conflict and it is easy to see that, incrementally, the likelihood of such a scenario increases as the death toll in Gaza mounts further, thus generating domestic pressure on neighbouring Muslim countries. Here, oil is the key shock transmission channel (given production sites and transit routes) for the global economy.
So far, we are seeing a repeat of previous stand-offs in this region, where the diplomatic route is being used to cool the situation and prevent bloodshed (this is also the reason why global markets have so far remained immune to the situation). However, as casualties increase the likelihood of unforeseen turns in the situation should not be ruled out.
Implications for global fixed income
We have already seen a temporary shift towards safe-haven assets as risk appetite has been dented on the back of these events late last week.
However, as noted above, there are still strong shock absorbers which exist in both situations (Russia softening her stance and US pressure on Israel). Already, the risk markets are starting to take comfort from the fact that scope for diplomatic solutions to both issues remains in place (a view we agree with, especially on the Russia/Ukraine front).
As such, we would expect the safe-haven driven yield compression in the global rates market to unwind (at least partially) in coming days as the focus on economic data returns. However, it is important to note that US rates were seeing downward pressure even before the geopolitical flare-up which took place over the last week.
Overall, we think that the scope for stabilisation in the Russia/Ukraine issue remains a higher probability scenario than currently perceived, while mounting casualties in the Mid-East conflict requires equal if not more attention, especially if a neighbouring Muslim country feels compelled to get involved in a bid to pacify its domestic audience. Here, we see the latest newsflow suggesting John Kerry’s visit to Cairo as a positive.
Salman Ahmed
Global & EM Fixed Income Strategist
Lombard Odier Investment Managers
