The Israel-Hamas war comes at a time of already elevated geopolitical tensions, with the ongoing war in Ukraine, and the intense geopolitical rivalry between the US and China. (UBS)

Worries that the war could spill over into a broader regional conflict, with the potential to disrupt oil supplies, initially appeared to have increased investor demand for safe-haven assets—including Treasuries, gold, and the US dollar.

But, the latest market moves suggest investors are hopeful that this downside scenario can be averted and the war can be contained, with a likely smaller feed-through into global safe-haven assets.

A continued fall in Treasury yields appears to owe more to receding fears of Federal Reserve rate hikes, rather than risk aversion. The yield on the 10-year US Treasury fell again on Wednesday and is now down around 30 basis points from Friday’s intra-day high of 4.88%. Safe-haven demand may have contributed to this move earlier in the week. However, this week's rally in risk assets, including a 0.4% rise in the S&P 500 on Wednesday for a gain of 1.6% so far in the week, suggests that yields are being driven more by comments from top Fed officials and expectations over the growth outlook.

A range of Fed policymakers have recently indicated that the rise in bond yields over recent weeks had been tightening financial conditions, reducing the need for a further hike this year. This was echoed by Fed Governor Christopher Waller on Wednesday, who said bond markets were “going to do some of the work for us.” Investors have also become more optimistic recently that moderating growth and inflation could enable the Fed to cut rates more swiftly in 2024, easing concerns from September that rates would stay higher for longer.

Geopolitical uncertainty looks likely to provide additional support to oil, beyond the outlook for rising demand and limited supply. Brent has stabilized after initially rising around 5% on the news of the Hamas attack, which added to fears that a broader regional conflict could disrupt oil supplies from Iran. Brent was up around 1.2% on Thursday at USD 86.87 a barrel. But this is still below an intra-day peak of USD 89 reached in the immediate wake of the attack.

We expect oil prices to move higher, ending the year around USD 95 a barrel. This largely reflects our view that global demand is continuing to rise, while OPEC+ oil exporters have been disciplined in constraining supplies. However, in an already undersupplied market, disruptions to Iranian exports either through a broadening of the conflict or tougher sanctions could have a significant impact on oil prices in the near term. Market participants are likely to watch for developments that might prompt the US administration to enforce stronger sanctions on Iranian crude exports.

A two-week high for gold likely reflects an easing of worries over higher US rates, along with potential safe-haven demand. The precious metal moved modestly higher on Thursday to USD 1,880 an ounce and is around 3% higher than a recent low struck late last week. Gold is a favorite haven for investors in periods of heightened risk. However, the metal also appears to be benefiting from optimism that the Fed rate hiking cycle has already come to an end and that rates could come down faster next year—which lowers the opportunity cost of holding non-interest-bearing assets like gold.

Uncertainty over the outlook for rates looks set to create headwinds for gold in the near term, in our view. But equally, those who are long gold should hold these positions in anticipation of a recovery over the next 6–12 months. We also highlight gold's long-term diversification benefits within a portfolio context remain intact.

So, the Israel-Hamas war comes at a time of already elevated geopolitical tensions, with the ongoing war in Ukraine, and the intense geopolitical rivalry between the US and China. At the same time, markets face a period of moderating global economic growth and gradually receding inflation, which absent a broader regional conflict in the Middle East, is likely to be the main driver for asset markets. This reinforces our view that investors should strengthen the core of portfolios, with a diversified multi-asset approach. On a tactical level, we see a better risk-reward profile for fixed income compared to equities, and we recommend investors consider buying high-quality bonds in the 5–10-year maturity range.

Main contributors - Solita Marcelli, Mark Haefele, Vincent Heaney, Christopher Swann, Matthew Carter, Alison Parums, Jennifer Stahmer

Original report - Safe-haven assets mixed as Israel-Hamas war continues, 12 October 2023.