When do geopolitics really matter for markets?

No one likes sitting around the proverbial fireplace and musing about the shifting tectonic plates in geopolitics more than us. While geopolitical events often capture significant attention, they generally do not have a substantial impact on bond and equity markets. This is not to diminish the tragedy of war and its real impact on communities affected, but rather to highlight that, absent a larger, more protracted conflict that draws in Western powers, geopolitical turmoil tends to have limited effect on bond and equity markets.

The United States launching direct attacks on Iranian nuclear sites recently threatened uncertainty as to how this latest escalation will evolve. The apparent cease-fire agreed upon by Iran and Israel suggests calm, at least for now. Despite the uncertainty, the lasting impact on bond and equity prices from this conflict will likely be minimal. This perspective seems somewhat incongruous to the plethora of video calls and high-level analyst research from investment banks flooding our inboxes, providing insights into the latest events.

To provide historical context around market behaviour, we looked at some key geopolitical events over the past 25 years – by no means exhaustive – to observe what, if any, impact foreign conflicts had on bonds and equities.

The table below uses the US S&P 500 and US 10-year Treasury as the bellweather indicators for stocks and bonds.

The list below is not comprehensive and there’s debate about which events should make the cut, but we feel we at least capture some of the larger ones. The move on T represents the market response on the day of the event, and T+1 is the following day.

The bottom line is that the average move in bond yields and equities is relatively muted.

When do geopolitics really matter for markets? Absent a large-scale, multi-country conflict that draws in Western powers in such a scale that economies suffer materially (basically WWIII), the impact will be contained.

The key exception to this is the oil price. Any significant and sustained surge in oil prices poses a clear headwind for growth and remains the primary risk that could shift the outlook. This risk could materialise if the critical Hormuz Strait, through which 20% of global oil passes, is threatened by Iran to the point of closure. However, we consider this as an outside risk given Iran’s dependence on oil exports, including to backers such as China. Notably, the current air campaign has seen Israeli forces avoid targeting oil export facilities.

In 2022, when Russia invaded Ukraine, oil prices surged to $120 a barrel due to fears of sanctions and supply disruptions. However, oil prices did not remain elevated for long, and the lasting economic impact on global markets was muted. We expect a similar outcome in the current situation. Even if supplies are temporarily interrupted, swing producers such as Saudi Arabia would likely increase supply and, for various reasons, a prolonged closure of the Hormuz Strait seems unlikely.

Crude Oil Futures Price (shaded area is when Russia invaded Ukraine)

For Australia, it is worth noting that 3-year government bond yields are within three basis points of their levels before Israel launched strikes on Iran.

Australian 3-year Government Bond Yields (13th June shaded represents Israel strikes on Iran)

Given the uncertainties to global growth, it is not hard to agree with current expectations of a rate cut in July from the RBA. That said, we maintain the view that the trajectory remains for modest easing, with domestic conditions still solid, as evidenced by the recent employment data showing unemployment unchanged at 4.1%.

While there is potential for things to worsen, it appears that history repeats regarding the impact on bond and equity markets.

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