Markets 101 in times of nasty world politics

Written by Reuters | London | Updated: Jul 24 2014, 05:57am hrs
Like so much in the investment world of late, its what financial markets are not doing right now that is most intriguing. Over the course of the past month, conflicts, superpower standoffs and economic sanctions have flared in Iraq and Syria, Israel and Gaza, Ukraine and Russia.

All are at least potential threats to world energy supplies, if not globalised business links and supply chains. Whats more, a September referendum looms on the potential breakup of the worlds sixth largest economy as Scots vote on secession from the rest of the UK.

Yet the worlds main financial markets have barely blinked. Crude oil prices gyrated briefly on the upsurge in the Iraq/Syria violence but net moves have been slight to non-existent. At around $108 per barrel, Brent crude is roughly where it was at the start of this year and where it started last year and even the year before that.

In the face of all this seeming uncertainty, energy price volatility has in fact sunk to its lowest on record.

For some, energy prices moved to discount this more economically integrated but less politically stable globe more than 10 years ago, when they quadrupled in the early 2000s. And the persistence of $100 plus per barrel oil in itself reflects that more fragile state of affairs. Little of whats happened this year will have materially altered that picture beyond a relatively small $1 or $2 pop in futures markets premia for near-term supply disruptions.

For all that strategists puzzle over the lack of price reaction to last weeks downing of a Malaysian airliner over Ukraine, many acknowledge that recent history does not support a view of either spiralling conflict or direct links between political violence and lasting market or economic fallout.

In my mind, the market is not assigning a high enough probability of this situation escalating to uncomfortable levels but the reality is the most likely outcome is that it doesnt, said Deutsche Banks Jim Reid.

Even if western sanctions on Russia the worlds eighth largest economy are ratcheted up and Russian markets are as exposed as their near 10% drop over the past 10 days suggests, investors know that seeing through periodic spikes in political tensions would have paid off time and again. Russia has oil and gas; it is inconceivable that the West will take any meaningful macro sanctions that would endanger the supply of Russian energy to Europe, said Jim Wood-Smith at Hawksmoor Investment Management. So there will be all the usual huffing and puffing ... with politicians all hoping everything will have calmed down in a few months.

That may sound too relaxed or even complacent given the stakes at hand. But if wars, coups and conflicts in energy-critical hotspots cant even excite oil prices for more than a few days, then its hard to see how the wider financial universe would be materially affected. The reaction on world equity markets would appear to confirm that. For all the short-term wobbles, world equity indices are up 0.6% for July and 5.6% in the black for the year.

Investors will most likely choose to see through sometimes shocking events to more mundane but dominant drivers such as the - currently distorted - U.S. interest rate cycle, and when those rock-bottom interest rates will start to rise.