Safe-haven assets in focus as Israel-Hamas war continues

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Safe-haven assets consolidated in early European trading hours, as markets awaited further news on the Israel-Hamas war. At the time of writing, high-quality bond yields held steady compared to Friday's levels. The 10-year US Treasury yield stood at 4.68%, around 20 basis points lower than the recent 6 October intra-day high of 4.88%. Brent crude oil traded around USD 91/bbl following a near 6% rally on Friday. Gold was around 1% lower at the time of writing, but is still around 5% above its 5 October low.

Over the weekend, Israeli forces continued to prepare for an imminent ground attack on the Gaza Strip, while hundreds of thousands of civilians sought to flee the expanding humanitarian crisis. Israel's Prime Minister Benjamin Netanyahu on Sunday said his military would “demolish Hamas,” while Iran's foreign minister warned it "would not remain an observer if crimes are committed in Gaza."

Diplomatic efforts are continuing on Monday, with France and the US among those pressing Israeli and Arab leaders to ensure the war with Hamas does not spill over and draw other nations more directly in the conflict. US Secretary of State Antony Blinken is scheduled to return to Israel on Monday after weekend meetings across the Arab world, with the Israeli government agreeing to lift a blockade of water supplies after US pressure. At the time of writing, there were conflicting reports on the existence of a ceasefire in southern Gaza and a reopening of the Rafah border crossing into Egypt.

Increased investor demand for safe-haven assets-including Treasuries, gold, and the US dollar-has followed worries of these spillover risks, with the potential for oil supply disruption a particular concern. We believe demand for quality bonds is likely to be supported by elevated levels of geopolitical uncertainty following Hamas's attack on Israel. Additionally, lower yields could follow as investors seek shelter in safe-haven assets.

In a scenario where the conflict expands and draws in other regional actors, we believe safe-haven assets including US Treasuries and gold would gain further from investors' attempts to hedge against stronger escalation or a global economic slowdown driven in part by higher oil prices.

High-quality bond yields can rally on both risk aversion and shifting expectations for US interest rates. Beyond increased demand for government bonds in periods of elevated geopolitical tensions, we think high-quality bond yields may be supported by commentary from Fed rate-setters.

A range of Federal Reserve policymakers have recently indicated 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 this past 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. We expect oil prices to move higher and end the year around USD 95 a barrel. This largely reflects our fundamental 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.

Gold may gain from risk aversion and lower opportunity costs... but its path may be bumpy. Many investors seek gold as a portfolio diversifier in times of geopolitical tension. Gold may also gain from shifting market expectations that the Fed hiking cycle has already come to an end, and that US rates could potentially come down faster next year if the implications of the war cause a faster-than-anticipated slowing in US economic activity.

Investors should note that uncertainty over the both the war and the outlook for US rates may lead to choppy prices for gold in the near term, in our view. But equally, we believe those who have long gold positions should hold these in anticipation of a recovery over the next 6–12 months. Our forecast is for gold to reach USD 1,950 by end-June 2024.

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 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.