Market Call: Monitoring Geopolitical Risk In the Middle East

The Santa Claus rally is about to be tested again by the prospects of a regional war in the Middle East. The Gaza War started on October 7, when Hamas attacked Israel. Yet both bond and stock prices have rallied since late October as investors bet that it would stay localized. So far, it has. Indeed, even the price of a barrel of brent crude oil has declined since then (chart).

Today, the guided-missile destroyer USS Carney and multiple commercial ships came under attack in the Red Sea, the Pentagon said. The US warship opened fire in self-defense as part of an hours-long assault claimed by Yemen’s Houthi rebels, who are supported by Iran. The price of oil will probably be the best indicator to monitor for geopolitical risk.

The rally in the bond market during November has been driving the stock market rally. Bonds even rallied on Friday though Fed Chair Jerome Powell said that while policy was well into restrictive territory, it was “premature” at this stage to speculate on when policy might ease. The bond market's risk-on party is visible in the narrowing yield spread between the high-yield corporate and 10-year Treasury bonds (chart). It has dropped from 564bps on March 24 to 412bps on Friday.