To The Moon

Hello Tigers,

This article was jointly written by Kevin Chen, chief economist of Horizon Financial, adjunct professor at New York University, and Cao Huining, professor at Cheung Kong Graduate School of Business.

1. Crude oil, gold and foreign exchange markets

 On Saturday, October 7, after the outbreak of conflict, crude oil futures opened with a sharp 4.5% gain on Sunday night. However, many fund managers and sell-side analysts on Wall Street generally felt that the crude oil market's response was below expectations.

The reaction appears to be lower than before for several reasons:

Firstly, crude oil $WTI Crude Oil - main 2312(CLmain)$ prices have already risen sharply in September due to production cuts by Saudi Arabia and Russia. Compared to prices a few months ago, crude oil is already up 30% and it will be difficult to continue the big rise.

Second, there is now a huge possibility that global economic growth will slow down and even enter a recession next year due to rapid interest rate hikes by the Federal Reserve, the European Central Bank, and others. The IMF and WB just lowered the global economic growth rate at their annual meeting in Morocco last week. With the prospect of a slowdown on the demand side, it is difficult for crude oil fundamentals to support a big price rise.

Third, most of the parties involved in the previous geopolitical crises in the Middle East were at the national level, with a high level of investor concern. At this around, the two parties to the conflict between the Gaza Strip and Israel are relatively not at the national level. Global investors believe that the power gap between the two sides is so wide that it should not deteriorate into a regional conflict.

Reaction of crude oil prices 5 days before and after the outbreak of the current conflict

In history, every geopolitical tension is reflected in the gold market. $Gold - main 2312(GCmain)$ rose 1.6% on the first day after the conflict broke out. It rose 5.4% a week after the outbreak. It is fair to say that gold's reaction was greatly in line with expectations at least in the short term.

Gold price movements in the last six months

As for the foreign exchange market, the reaction of investors was more complicated. First, the traditional safe-haven currencies including the Swiss franc and the Japanese yen have seen minimal volatility. The dollar index, on the other hand, has appreciated to some extent. The appreciation of the dollar against the euro can be caused by the flow of European funds into the United States in order to hedge. The yen counterintuitively no longer appreciated, possibly reflecting that safe-haven funds are reluctant to go to Japan for the current zero interest rates from Japanese.

US Dollar Index Chart

 2. Israeli financial markets

After the start of the war, Israel's financial markets went into full risk aversion mode. Volatility on the Tel Aviv Stock Exchange (TASE) increased, with the Israeli stock market index falling 7% on Monday. It was a record one-day decline. Israel's listed companies are mostly financial and technology stocks, and a large number of them belong to the small-cap stocks, which are more affected by liquidity. However, many stocks of cyber security companies rose against the market. Because of the outbreak of this conflict, Chevron Oil's oil and gas fields in Israel were forced to shut down production, which is a negative event for Israel's economic growth.

After the outbreak of fighting, the Israeli currency, the shekel, fell to 3.92 against the dollar (its lowest level since 2016) before rising slightly. Israel's central bank said it would sell up to $30 billion worth of foreign exchange reserves to stabilize the currency and "provide the necessary liquidity for the continued normal functioning of the market." Israel is a highly externally oriented economy, so the conflict cause great damage to the real economy. It’s expected to have a drop in capacity in manufacturing and services. At the same time the massive military spending will inevitably lead to a rise in the government's fiscal spending and an expected rise in the tax burden.

Increased conflict or tensions with Hamas may deter tourists and foreign investors from visiting or investing in Israel. This could have a negative impact on sectors such as tourism, hospitality and real estate, which in turn could have a ripple effect on the wider economy.

In Israel's bond market, particularly treasury bonds, have also been informative. According to the Standard & Poor's agency, Israel's credit rating is AA-. After the outbreak of war, Israel's treasury curve began to steepen: short-end interest rates fell sharply, with safe-haven funds flooding into Israeli treasury bonds. Interest rates at the long end rose, signaling a rise in inflationary expectations due to war spending.

Israel's Treasury Yield Curve on October 15 vs. One Month, Six Months Ago

Israeli one-month, three-month, six-month to 30-year Treasury yields and historical comparisons

3. Financial markets in Europe, Asia and the United States

The European economy has grown weakly this year, with the German economy already in recession. The outbreak of war in the Middle East added to their woes in stock markets. Stock markets across Europe also opened lower on Monday, stabilizing slightly after traders digested the war news. France's CAC 40 index fell 0.6%, while Germany's DAX index fell 0.7%. London's FTSE 100 index rose a modest 0.03%, supported by gains in oil company shares.

In Asia, investors initially had a mixed reaction. In mainland China, the Shanghai Composite Index was down 0.4% after reopening after the overlapping National Day Mid-Autumn Festival holiday week. Meanwhile, Australia's S&P/ASX 200 closed 0.2% higher. In a way, demand for Australia's exports of natural gas, mineral grain may be on the rise. Hong Kong's Hang Seng Index rose 0.2% after trading resumed following a suspension due to a typhoon.

U.S. stocks opened lower on Monday but closed higher. The overall U.S. stock market witnessed great volatility. Equity fund managers on Wall Street saw overall risks contained, while the energy sector and defense sector rose. The bond market reacted more vigorously. What happened in line with the gold surge was a big jump in U.S. Treasuries, especially a spike in long-term Treasuries. It's possible that economic growth is really starting to slow down, which would also be good for U.S. Treasuries.

U. S. crude oil inventories recently surged by 10 million barrels

 4. the digital currency market

Bitcoin fell slightly after the outbreak of war in the Middle East, beyond expectations. The main reason was that media reports on Monday the Israeli government froze digital currencies such as Bitcoin belonging to Hamas in several centralized digital currency exchanges. Global investors are skeptical about the ability of digital currencies to avoid regulation, potentially shifting them to decentralized wallets and leading to less liquidity in digital assets.

5. Outlook

The U.S. stock market is facing a dangerous tipping point given the high interest rates driven by the U.S. Federal Reserve, the stalemate over the conflict between Russian and Ukraine, the turmoil in the Middle East, the trade friction between the U.S. and China, and the chaotic internal politics of the Republican leadership in the U.S. Congress. We expect, as the great fluctuations the rest of this year and the beginning of next year, there will be a correction in global financial markets soon likely. It’s recommended that investors need to diversify risk, being mindful of exposure across major asset classes and cash flow management, and avoid extreme events.

Recently there has been a perception of shorting Treasuries due to the possibility of higher oil prices causing Treasury rates to continue to rise. In fact, the U.S. Consumer Price Index (CPI) as a whole has risen 35 basis points in the last three months, but the core CPI has only risen 3 basis points. In addition, the increase in gasoline prices could severely dampen the behavior of low-income consumers, thereby weakening demand in the economy. Therefore, investors should not assume that higher oil prices will lead to a more hawkish central bank stance. The recent situation in the Middle East actually proved that safe-haven demand can lead to lower short-term interest rates.