GRACELIN BASKARAN: Politics the major influence in moving markets

I was in the UK last week in the office of a friend who is a partner at a major global hedge fund. His rules of trading, which have made him wildly successful, are posted on the wall. One of his top rules? It’s politics — not economics — that moves markets.

The effect of the crisis in the Middle East on energy prices is slowly unfolding. 

On October 10 the Financial Times published an article headed “Nervous but not terrified: oil markets shrug off Israel conflict”. Brent crude sat at $87.56/barrel at the time, well below the $97/barrel it hit in late September. 

Three days later it published another article, “Oil jumps above $90 on concerns over escalation in Israel-Hamas war”. Concern that there could be a ground assault on Gaza escalated concern about the future of commodities markets. 

Five days later, on October 18, Brent crude prices pushed up further after the hospital bombing in Gaza left hundreds of Palestinians dead. Prices reached $92.75 and analysts are expecting oil to hit $100/barrel in the short-term.

Rising oil prices and deteriorating sentiment on the stability of oil markets is going to further dent efforts to combat inflation, laying the foundation for keeping high interest rates. This sentiment has been echoed by international financial institutions.

World Bank president Ajay Banga said recently that “central banks were beginning to feel a little more confident that there was an opportunity for a soft landing, and this kind of just makes it harder”. 

The effect of the Israel-Hamas war will inevitably erode gains on the effort to rein in inflation. Atlanta Federal Reserve president Raphael Bostic was one of the first US central bank officials to comment on the crisis at the American Bankers Association conference last week. “This is just another new, unexpected thing that is going to cause everyone to have to rethink where our markets are going to be, where our partners are going to be.” 

As we enter the most uncertain period in the Middle East in modern memory, it’s probable that the worst is yet to come in human security and energy prices. The extent to which prices rise will depend on whether Iran enters the conflict. Iran has long financially backed Hamas. If the conflict includes Iran, there will be inevitable calls to bolster sanctions on Iranian oil exports. 

This will have a significant effect on global oil prices. Iran has had a growing presence in the international oil market. Its oil production increased by 500,000 barrels/day (bpd) between March and September, with crude output exceeding 3-million bpd and exports reaching 1.6-million bpd. Iran’s oil exports reached a five-year high ahead of Hamas’s attack on Israel. 

Saudi Arabia’s response will also play an important role in price formation. In the months leading up to the Israel-Hamas crisis the country was on its way to normalising relations with Israel. Riyadh had developed conditions for normalisation, which included security guarantees from Washington and support to developing a civilian nuclear programme, if Israel confirmed it was okay. 

The normalisation talks between the two countries have now been paused. Saudi Arabia’s foreign ministry released a statement affirming “its categorical rejection of calls for the forced displacement of the Palestinian people from Gaza, and its condemnation of the continued targeting of defenceless civilians there”. 

At present there is no indication that Saudi Arabia will impose oil restrictions as it did in the 1970s when Arab countries in the Opec oil cartel imposed an embargo on countries that supported Israel during the Yom Kippur War, including the US, UK, Canada, Japan and the Netherlands. This triggered the 1973 oil crisis, when oil prices quadrupled. 

Such an approach would be a contradiction of Saudi Arabia’s efforts to become a global leader in the areas of nuclear, critical minerals and oil. It has deepened ties with Western countries on the energy front. In recent months the US and Saudi Arabia agreed to collaborate on a $15bn investment in Africa’s critical minerals and Saudi Arabia requested US nuclear power technology and expertise. 

For the foreseeable future it is likely that Saudi Arabia will take a diplomatic position, without bringing in energy security as a bargaining tool. Iran is more likely to throw a spanner in the energy markets. 

There’s no doubt we’re in a period of intense uncertainty. We’re just starting to see the effect on energy markets. The resulting inflation will give way to sustained high interest rates. It’s just another example that it’s primarily politics, rather than economics, that moves markets. 

• Dr Baskaran (@gracebaskaran), a development economist, is research director for energy security & climate change at the Centre for Strategic & International Studies in Washington DC.