Tensions in the Middle East are escalating but this is not yet reflected in the movement of bond yields. As interest rate uncertainty diminishes, investors may have to pay more attention to the unravelling situation between Israel and its regional foes.
Monday marked the first anniversary of Hamas’s deadly attack on Israel. As the anniversary approached, fighting on the ground ensued in Lebanon, Iran launched direct attacks on Tel Aviv and Jerusalem, and the war in Gaza raged on.
The world is familiar with these events. Investors seem positively comfortable with them.
Or at least they worry far more about what the world's biggest central banks are doing with interest rates, which is not surprising given where we have been at in the monetary policy cycle this year.
When Iran showered around 200 ballistic missiles on Israel on October 1, 10 year US Treasury yields moved from 3.79% to 3.72%, according to MarketWatch. The release of the ADP National Employment Report the following day comfortably unwound this movement with change to spare.
Investors and traders have been even more attuned to economic data this year as they look for clues as to what the Federal Reserve and the ECB might be thinking about setting interest rates, especially now that rate cutting is underway. But there is a good chance that monetary policy will soon become boring again, at least by comparison.
Inflation is coming back to target levels, meaning uncertainty surrounding the outcome of central bank monetary policy meetings will ease.
Although interest rate uncertainty will recede, geopolitical risk will remain. At that point, market reactions to events in the Middle East, especially if the conflict escalates, might look a lot different than they do today.
Recent escalations in the Israeli war have been undeniably severe. A key threat, of course, is whether other countries are sucked into the fighting.
Take the US as one possible example. Before the Iranian missile barrage US officials warned of “severe consequences” if the attack was to take place.
When the US went to war in Afghanistan it resulted in two decades of warfare in Iraq and then Afghanistan, among other conflicts, financed by debt.
One may argue that this did not affect borrowing costs for the world’s largest economy, but debt levels were not what they were back then.
October 7 is an inauspicious date for world peace. It was the day in 2001 that the US invaded Afghanistan. Two years later it invaded Iraq.
Between 2001 and 2008, when financial crisis gripped the world, its debt-to-GDP ratio rose from 54.8% to just 67.5%, according to Trading Economics. Last year it was 122.3%. It is unlikely that war has become cheaper.
That raises the question of what it will take for Israel's conflict to make investors react to it. Hopefully this remains a rhetorical poser. But as the war boils, and interest rate policy cools, the capital markets may have to come up with some answers and fast.