'We are watching to see if something breaks.' The concern expressed by Fidelity International applies not just to surging bond yields but to fuel prices and inflation, as the world watches and worries.
An 8 percent slide in the price of oil last week looks set to be short-lived following dramatic events over the weekend in the Middle East.
Israeli Prime Minister Benjamin Netanyahu declared war on the militant Palestinian group Hamas after it rampaged through several Israeli towns killing more than 250 citizens and taking many others as hostages.
It was by far the deadliest day of violence in Israel since the Yom Kippur War almost 50 years ago to the day, and comes at a time when Israel and Saudi Arabia, the world’s largest oil producer, had been on the verge of an historic diplomatic accord designed to normalise relations between the two former enemies and potentially triggering a fall in the oil price.
READ MORE: * Gaza war tears a rift in NZ’s ‘single voice’ on foreign affairs * Chris Hipkins condemns Hamas 'terror attacks' * Stephen Hoadley: Why attack now, and who benefits?
Prior to the weekend attack, there were reports that Saudi Arabia had told the White House, which has been seeking to broker the accord, that it would be willing to increase oil production to help cement a deal, in return for US assistance to develop a civilian nuclear program – a plan strongly opposed by hard-right political leaders in both Israel and the US Senate.
The finger is being pointed at Iran, which is close to Hamas. Iran is seeking "to put pressure on their implacable foe Israel" with this attack, says retired Navy admiral James Stravridis, the former commander of NATO, speaking on America’s NBC News network.
Coming at a time of continuing military conflict between Russia and Ukraine that has already led to higher energy prices, the last thing the global economy needs right now is an escalation of tensions in the Middle East pushing oil prices even higher.
"History doesn’t repeat, but it often rhymes," the Washington Post pointed out to its readers in the wake of the attacks, coming as they do on the eve of the 50th anniversary of the world’s first oil crisis, in October 1973.
"Parallels are easy to draw, though it should be noted that this time the price of oil isn’t being hiked by 100 percent as occurred 50 years ago."
However, political analysts believe the fallout could yet have a significant impact on oil markets in the near term and possibly even into next year if Israel concludes that Hamas acted on instructions from Tehran and retaliates accordingly.
That could see Iran respond by knocking down a significant chunk of Saudi oil production capacity as it demonstrated previously in 2019.
Iranian oil output has surged to nearly 700,000 barrels a day this year – the second largest source of incremental supply behind US shale production. Likely White House sanctions could therefore easily push oil to US$100 a barrel, and potentially beyond, if that supply is negatively impacted.
As so often occurs in financial markets, it’s the unforeseen ‘Black Swan’ events that can quickly disrupt the equilibrium. Barely a week after it appeared some welcome relief from higher oil prices was in sight, consumers – and Central Banks battling inflation – now face the potential of a new round of Middle East tensions pushing oil prices even higher.
Reserve Bank plays a straight bat but warns of risks ahead
While there was little surprise at the Reserve Bank’s latest decision to leave the official cash rate unchanged, it did warn of “near-term risks” that activity and inflation do not slow as much as needed may necessitate further action.
"The recent rise in global oil prices could increase domestic costs over coming months, risking headline inflation being higher than expected," the bank noted in its statement.
It said while gross domestic product growth in the June quarter was stronger than anticipated, the outlook was still subdued and spending was expected to fall further. It also noted that a global slowdown in economic demand, particularly from China, could weigh on commodity prices and sap New Zealand’s export revenue.
The central bank also pointed to weakness in manufacturing and services indices and the NZIER’s quarterly business opinion survey, which both showed easing capacity pressures. The survey found a net 7 percent of businesses were finding it easier to hire staff, one of the softest readings in more than a decade.
Stephen Toplis, BNZ’s head of research, said the Reserve Bank used some measures from the survey to estimate the maximum level of sustainable employment.
"We have long said the secret to stabilising prices in the medium term is to alleviate the excess demand that had developed in the labour market during the COVID era."
Kiwibank chief economist Jarrod Kerr noted the downside risks the RBNZ highlighted carry much greater consequences.
"One of our greatest strengths is also one of our greatest weaknesses – and that’s China, our largest trading partner. China has failed to bounce out of lockdown, and the problems with its property market are worsening. We’re feeling the effects already, including lower dairy prices."
Surging bond yields has markets worried about negative impacts
A sell-off in global bond markets has pushed borrowing costs to their highest levels in more than a decade.
The New Zealand 10-year Government bond yield gained a further 25 basis points for the week to 5.61 percent, while in the US the 10 year Treasury yield jumped another 5 percent for the week to 4.8 percent having surged more than 40 percent since early May. Bond prices fall as yields rise.
Policymakers and investors are becoming increasingly wary that the latest round of sharp moves in bond markets could inflict severe damage on various parts of the financial system.
"We are watching this ... very carefully to see if something breaks," Salman Ahmed, global head of macro at Fidelity International told the Financial Times.
The collapse in bond prices, which is now being compared with the collapse of the dot.com bubble in the year 2000, will also mean potentially heavy losses for US banks, insurers, pension funds and asset managers that own trillions of dollars of sovereign and corporate debt after loading up on the asset class in recent years.
While most banks, and in particular the largest ones, will not have to sell and so will never realise those losses, the implosion of midsized US lender SVB and California based First Republic Bank in March has refocused the minds of regulators and investors on the risks lurking in bank bond portfolios.
On the flip side, higher rates create more incentive for depositors to move their money on to fixed term, forcing banks to pay up to keep accounts — which ultimately hurts profits, while also weighing on sharemarkets as investors get paid more for taking less risk by simply keeping their money on deposit.
Corporate debt markets have also come under intensifying pressure from the sharp rise in government bond yields, which feeds through to companies’ borrowing costs, while higher debt servicing costs by governments will mean they have less to spend on health, education and other priorities.
Meanwhile, the number of jobs in the US surged more than expected last month, fuelling expectations that further interest rates before the end of the year could still be on the cards.
Employers added 336,000 jobs in September, almost double the 170,000 estimated, according to figures released by the Labor Department on Friday (US time).
Data for August was also revised higher to show 227,000 jobs were created instead of 187,000 previously reported.
The unemployment rate in the US remained unchanged at 3.8 percent.
However, the jobs market's continued resilience in the face of the Federal Reserve's attempts to cool down the economy saw traders adding to bets that the central bank will, once again, raise interest rates before the end of the year and keep them elevated for longer next year.
FTX founder faces damning testimony from former colleague
The trial of high profile FTX crypto exchange founder Sam Bankman-Fried who faces multiple counts of wire fraud and money laundering finally got underway in New York and is being closely followed by both regulators and former customers who lost billions of dollars when the business collapsed in November last year.
In damning testimony for Bankman-Fried, it was revealed the company’s trading division Alameda Research began secretly dipping into customer funds just months after it was founded, the company’s co-founder testified.
Gary Wang, a former college roommate of Bankman-Fried’s who became one of his closest friends and colleagues, told the jury in Manhattan federal court on Friday that he had been instructed in 2019 to let Alameda have a negative balance on FTX.
Along with a “large line of credit” from the crypto exchange, that meant Alameda was soon in effect “taking customers’ money”, Wang said.
Wang added that a secret and unique borrowing facility for Alameda was activated the same day — July 31 2019 — that Bankman-Fried took to Twitter to assure FTX users that the trading firm’s accounts were treated “just like everyone else’s” on the crypto exchange.
That facility was only available to Alameda’s accounts from that date until FTX imploded in 2022, Wang said, during which time the trading firm’s line of credit was raised several times, eventually to as much as US$65bn.
When Wang asked Bankman-Fried about the final credit raising, “he said he was fine with that”, the co-founder said.
The testimony by Wang, who pleaded guilty to fraud soon after FTX’s collapse and agreed to co-operate with prosecutors, is the most damning so far for the 31-year-old Bankman-Fried.
If convicted, he could face decades in prison. He has pleaded not guilty to all charges, and his lawyers have argued he was simply acting in “good faith” and never intended to defraud anyone.
Coming up this week…
Tuesday
- Gentrack – Shareholders Meeting
Wednesday
- Rua Bioscience AGM
- International Migration & Travel (Aug) – Stats NZ
Thursday
- Livestock Improvement AGM
- Meridian Energy AGM
- Food & Rental Price Indexes (Sept) – Stats NZ
Friday
- Genesis Energy AGM
