Is it back to the 1970s as global macro storm clouds loom?

Reuterts/Beawiharta

According to Wall Street folklore, there are four heartbeats in global finance; the price of money (US Treasury bond yields); the price of currency (the US dollar Index); the price of crude oil (Brent is the planet’s benchmark); and the price of gold (a presumed hedge when inflation rises).

The macro storm clouds have suddenly darkened over global financial markets as strong economic growth data in the US has now eliminated any hopes that a pre-election Fed will pivot to lower interest rates. 

As long as inflation expectations are far higher than its 2 percent target, the Federal Reserve’s dual mandate precludes the three rate cuts in 2024 that were priced into the capital markets only a month ago. 

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In fact, the majority of the voting members on the Federal Open Market Committee, or FOMC, the Fed’s chief body for monetary policy, now expect year-end consumer price inflation to exceed 3 percent.

No wonder then that the bond vigilantes have done a Rip Van Winkle and dived back into the haven of government debt.

They have pushed the yield on the US Treasury 10-year note to 4.64 percent currently and could well drive it to 5 percent or even higher. This will have a huge impact on the GCC, because it will lead to a rise in the US dollar against the world’s currencies. 

The logic of the GCC currency pegs mean higher bank lending rates and higher borrowing costs for corporate bonds and sukuk issuers.

Higher borrowing costs, slower credit growth, and now an Iran/Israel confrontation mean that regional stock markets could face a correction. GCC bonds/sukuk prices will fall and leveraged property bulls will meet their macro nemesis.

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The US dollar index was at 101 at the start of 2024. It is 106 now. When the price of money and currency rises, risk assets move into the twilight zone. This is as true in the financial souks of the GCC as it is on Wall Street.

There is no doubt that Israel and Iran have crossed a geopolitical Rubicon, with their strikes on each other’s homelands, violating a red line for the first time since the final Pahlavi Shah lost his peacock throne in 1979. 

Both the Israeli and Iranian strikes in the middle of last month were well telegraphed and designed not to inflict mass casualties.

But the idea of two sworn enemies playing games of drone/missile chicken in the heart of the Middle East means that a geopolitical risk premium on Brent crude is inevitable on any miscalculation or escalation.

Brent has fallen from its initial spike to $92 a barrel, but the conflict’s potential to disrupt oil supplies and thus ignite inflation are compelling arguments for the US central bank not to cut interest rates prematurely. 

Achilles heel

The Achilles heel of the global oil market is the fact that any escalation of conflict in the Middle East could threaten the world’s most critical tanker shipping choke points and largest oil infrastructure complexes in the GCC.

After all, 18 to 20 million barrels of black gold are transported daily across the Strait of Hormuz, which Iran has threatened to close in the past. Iranian and Houthi missiles have also attacked Saudi Arabia’s Abqaiq oil processing complex and Adnoc facilities in Abu Dhabi.

It is thus unwise to short Brent in the mid-80s; any escalation in the Middle East could trigger a spike well above the recent $92 high.

Bull runs in gold are normally correlated with lower interest rates, because the opportunity cost of holding aurum rises when the price of money rises. After all, gold bars generate no income, unlike bank deposit rates or corporate/government bonds.

Not this time. Even the consistent rises in both US Treasury bond yields and the US dollar in 2024 have not derailed the bull market in gold, as its price now flirts with $2,400 an ounce. This is because the current macro bogeyman for gold bugs is inflation and mid-east geopolitical risk. 

Who could have believed that gold would rise 16 percent in the past three months despite a hawkish Fed?

Too bad pawnshops are not listed on the stock exchange. Hong Kong-listed jewellery store chains should do well, since Chinese gold bugs also have to hedge a black hole in their property portfolios and shadow banking exposure, a public debt Frankenstein and the risk of Beijing delivering a policy shock. 

After all, who could have believed that gold would rise 16 percent in the past three months despite a hawkish Fed, or that King Dollar would run amok on Planet Forex? 

Does the world face a replay of the 1970s? Then, inflation angst, a tight money Fed, Mid-east wars and a sovereign debt crisis in major economies led to epic bear markets on Wall Street. Hopefully we do not have to re-learn the dismal lessons of the 1970s the hard way.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also adjunct professor of real estate investing and banking at the American University of Sharjah