Markets Brace for More Volatility Amid Israel Conflict

Traders are bracing themselves for another week characterized by turbulent fluctuations in asset prices, with ongoing conflicts in the Middle East driving demand for safe-haven assets and compelling investors to reassess their perspectives on global interest rates.

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When the markets reopen at 5 a.m. in Sydney, all eyes will be on the US dollar, Japan's yen, and the Swiss franc, which are considered traditional safe havens during times of geopolitical turmoil. Meanwhile, currencies more susceptible to risk, including the Australian dollar, experienced selling pressure early last week and may encounter similar challenges. The price of gold saw its most significant surge since March on the previous Friday.

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Oil prices and Treasuries will also be under intense scrutiny after a week marked by volatile bond markets, with yields swinging wildly, delivering the most significant gains and losses seen in years. In Israel, the primary stock index, the TA-35, resumed its descent on Sunday.

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The Israeli military has indicated preparations for "significant ground operations" in Gaza, while the United States engaged in behind-the-scenes discussions with Iran in recent days to caution against further escalation of the conflict. US Secretary of State Antony Blinken is scheduled to make a second visit to Israel on Monday following a tour of the Middle East, which included stops in Jordan, Bahrain, Qatar, Saudi Arabia, and the United Arab Emirates.

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Bloomberg Economics has raised concerns that a broader conflict in the Middle East could tip the global economy into a recession. This adds another layer of apprehension to the growing list of concerns among investors, including doubts about whether the Federal Reserve has concluded its interest rate hikes and how the US Congress, faced with political gridlock, can avert a government shutdown.

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A deteriorating macroeconomic environment, coupled with sharp fluctuations in interest rates, has laid the groundwork for heightened global market volatility, as noted by Ed Al-Hussainy, a global rates strategist at Columbia Threadneedle. While global investors are keenly monitoring the potential spillover of the Israel-Hamas conflict into the broader region, currency traders, for the moment, are placing greater emphasis on the Federal Reserve's actions.

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While broader measures of market volatility remain relatively subdued, the Swiss franc has surged to its highest level against the euro in over a year, and the US dollar has posted gains for a fourth consecutive week. Volatility in S&P 500 stocks has also seen an uptick.

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The US itself is not without uncertainty, contributing to the potential for additional market fluctuations. Last week, a report indicating heightened inflation fueled expectations of further interest rate hikes by the Federal Reserve, eclipsing initial safe-haven flows and causing the most substantial one-day selloff in 30-year bonds since the onset of the pandemic.

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An index tracking anticipated price volatility in the world's largest Treasury exchange-traded fund now exceeds that of the largest stock fund this month by the greatest margin since at least 2005, based on Bloomberg's data.

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Furthermore, the US House of Representatives is still lacking a clear leader. Republicans have put forth Jim Jordan, who enjoys the endorsement of former President Donald Trump, but he faces significant hurdles in securing the speakership as more moderate party members are concerned about his hardline positions.

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Nevertheless, the ongoing Middle East conflicts remain the most unpredictable factor for investors to grapple with. As Jane Foley, the head of currency strategy at Rabobank, points out, there is a collective sense of anticipation, with everyone anxiously awaiting the direction these events will take. The market remains in a state of vigilance as it assesses the implications of these geopolitical tensions on the oil supply and broader financial stability.

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