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In recent years, Fridays in June have often been seen as a good moment for working from home by financial operators. Not now.
With news spreading about Israeli airlines being attacked by Iran, traders across Wall Street and London, not to mention Asia, rushed back to their offices to prepare for the inevitable storm.
It was realized quickly. Oil prices have skyrocketed (initially around 13%), stocks have fallen (initially 1%), and the dollar has overturned a recent downward slide. And although these movements were partially erased later, the volatility could remain high. In particular, US President Donald Trump warns that without a deal, the next “already planned attack” by Israel will be “even more cruel.”
So, what should investors think? There is good and bad news. The former revolves around the issue of oil. At first glance, it seems reasonable to assume that rising oil prices will be a troubling blow to global growth.
Iran’s “only” produces around 3.3 million barrels of oil per day, according to around 3% of the world’s total, but the real threat is that if further conflict closes the Strait of Hormuz, it will undermine transport. Certainly, ING Barings is an extreme worst-case scenario: a long blockage of the straits, and we hope that oil prices could double their record highs later this year.
20th century history shows just how harmful the rise in crude oil prices can be. And the World Bank has only reduced its global growth outlook to 2.3% by almost half the rate, the lowest since 2008 — is now a bad moment for another shock.
Trump on Friday claimed that the strike would ultimately be “the greatest thing ever for the market,” but the impact created short-term stress. High oil prices undermine Trump’s team’s plans to lower inflation. Also, given the risk of stagflation, it makes it difficult for the Federal Reserve to cut fees. It’s even worse for Europe.
But here is the good news, or at least the problem that is not suppressed. One of the more prominent, but ignorant developments in recent decades is the relentless decline in the so-called “oil strength” of the world economy, the amount of barrels needed to fuel each unit of growth – has been mercilessly reduced.
For example, in 1975, the World Bank calculated that 0.12 tons of oil equivalent (toes) were needed to produce $1,000 in GDP. But by 2022, it was only 0.05 due to the spread of renewable energy sources like the sun and increased industrial efficiency.
Therefore, we will not face your grandfather’s or father’s economy. Shocks like the Israeli attack don’t have to be as devastating as before. This is not the case when the main transmission channel for this shock is oil.
But the bad news is that it’s not just current transmission channels. Instead, I think the most important channel is investor psychology.
What the Israeli strike has done is to reinforce the perception that it is not only plagued by increasing geopolitical instability, but also suffered by periodist change. The vicious competition against hegemonic forces seems to have evacuated even the fig leaves of international cooperative norms and law.
Or again, to quote Trump, events are driven not by the sense of universal law, but by the question of who has the “card” (or not). Therefore, Israel feels that it can use military “cards” to bomb Iran freely, regardless of UN norms.
It is disorient, if not frightening, for investors raised to predict the future with a clean economic model. After all, in the neoliberal era, these models usually eliminated cluttered politics. And we assumed that the rule of law was consistent in both domestic and international fields. “The traditional world order in which economics has shaped politics is directed above its head,” as Pimco told client this week, “Politics is currently driving the economy.”
So, what should investors do? One important step is to recognize that older economic models are often useful, but now they are dangerously incomplete.
The second is to read more about financial history, sociology and psychology. Personally, I think that useful ways to frame today’s events can be found in the writings of political scientists like Albert Hirschmann, Carl Schmidt and economists John Maynard Keynes and Charles Kindleyberger. Anthropologists such as David Graeber, Arjun Appadurai and James Scott can also help.
Third, in a world where “fragmentation of trade and security alliances is becoming a powerful source of volatility,” we must once again recognize that diversifying our portfolios and watching events for a long time and taking deep breaths is essential.
The bottom line is that if you work in finance, don’t plan many Fridays this summer. It’s not just because tensions in the Middle East are rising. There are all risks too, too, too, as well as the US president’s decision to reshape the global order. Volatility is a feature, not a bug at the moment.
Since this article was first published, Iran’s daily production has been revised.
gillian.tett@ft.com
