Review of the week: Big trouble in the desert

A small-time war at the southern tip of the Middle East has spilled over into one of the world’s most important oil producers. Our chief investment officer Julian Chillingworth explains how it flared up and where the flames might be headed.

Half of Saudi Arabia’s oil production was knocked out of action by a surprise military strike at the weekend. Overnight, the global oil supply dropped by roughly 5%, sending the price of Brent Crude soaring 8.3% to trade at more than $65 this morning.

Houthi rebels, a radical Shia Muslim pirate army that came up in northern Yemen in the mid-1990s, claimed responsibility for the attack. For years they have been fighting the (mostly Sunni Muslim) Yemeni government, which is backed by Saudi Arabia. It would be fair to say that rather than a civil war, it is but one front in a Muslim religious war that long ago devolved into one of pure power politics. Part of a sort of Middle Eastern Thirty Years’ War, except with AK-47s and grenade launchers rather than pikes and muskets. The Middle East is split down the middle by the major Islamic divide between Sunni and Shia. Yemen is a microcosm of this: split virtually 50/50, between the Shia north (Houthis) and the Sunni south (Yemeni government). As the largest Sunni kingdom, Saudi Arabia is supporting the south, while the predominantly Shia Iran backs the Houthis. For context and to understand a bit more of the regional intrigue, it’s probably best to round out the list by noting that Iraq is also mostly Shia. Under the surface of the Middle East is a long-time struggle between two strands of Islam (complicated by many more splinter groups and religious sects) that has been raging for more than 1,000 years.

So how can a rag-tag band of rebels in one of the most impoverished countries on Earth devastate so much so easily and so swiftly? The Americans are suspicious. The Houthis themselves claim that they sent 10 remote drones across the border and more than 500 kilometres of desert to bomb the refineries. However, the White House is laying the blame squarely on Iran, even as investigations continue. America is looking into whether cruise missiles fired from Iran or Iraq did the damage. US President Donald Trump himself tweeted that US forces were “locked and loaded” to retaliate against Iran if definitive proof is found. In fairness, he didn’t name the nation he suspected, but Mr Pompeo had already done that. We’ve lived through years of Mr Trump’s bombastic rhetoric though, and it’s interesting to note that he has actually been one of the least warlike of any modern US presidents. He has been extremely reluctant to jump into any new conflicts and tried, as much as possible, to retreat or tread water in existing ones.

So what has all this got to do with the price of petrol? Well, if this is a major escalation in the regional conflict, than what’s to say that another attack on the oil industry won’t be successful? Refineries, oil tankers and pipelines have all been proven highly vulnerable to sabotage. Saudi says it will use reserves to plug the immediate production shortfall, but markets aren’t sure about how long it will take to repair the damage, either. There is also the option for OPEC to increase the production quotas for the cartel’s other members, something quite a few would welcome.

All in all, just what our world needed: more excitement.
 

Index

1 week

3 months

6 months

1 year

FTSE All-Share

1.4%

2.0%

5.9%

5.1%

FTSE 100

1.2%

1.3%

5.7%

5.9%

FTSE 250

2.5%

6.2%

7.4%

2.8%

FTSE SmallCap

1.2%

-0.6%

3.1%

-1.5%

S&P 500

-0.2%

6.3%

14.4%

10.4%

Euro Stoxx

0.6%

4.5%

12.6%

6.2%

Topix

2.3%

7.0%

12.0%

4.9%

Shanghai SE

1.4%

4.6%

1.7%

15.8%

FTSE Emerging

0.6%

3.8%

7.1%

11.8%

 
Source: FE Analytics, data sterling total return to 13 September
 

Everyone seemed so chipper

Before all that drama, investors were pretty cheered on the economy last week. There was a massive switch in the fortunes of stocks. Those that are more sensitive to sags and uplifts in the economy jumped higher after months of poor performance. Meanwhile, those companies with more stable earnings that investors had been clamouring after all year tumbled.

This time, the US and China are going to patch up their differences and settle their trade situation. This time. To be fair, this time may be different to all the other times over the past year and a half when the two were rumoured to be burying the hatchet only for things to get worse. After US President Donald Trump delayed some of the tariffs due to be slapped on Chinese imports, China reciprocated by dropping its own additional import levies on American pork and soybeans. Dovetailing with a change of tack in negotiations to focus on commerce alone (rather than bundled with national security), it may indeed represent a cooling in the trade war. Especially as the electoral Trump train is preparing to pull out of the station for the 2020 race and getting “a win” on Chinese trade would be helpful on the stump.

Add to that Mr Trump’s proclivity to buy votes with tax cuts and you could paint yourself a pretty chipper image of American economic growth. Or, at least, a portrait that was brighter than the one people had in their heads only a couple of weeks ago. To be plain, we believe the economy isn’t as imperilled as many thought it was. And we are more dubious of the potential for a dramatic uplift over the coming months than the investors who last week sent markets shuddering in a different direction.

You’ll want to keep an eye out for the US Federal Reserve’s (Fed) interest rate decision on Wednesday. The Fed is widely believed to have already locked in another 25-basis-point cut in the Fed Funds rate, which would take the benchmark range to 1.75% to 2.00%. If the Fed goes ahead as ostensibly planned, markets are likely to barely budge. But if it goes off-piste, buckle up.

The BoE has a rate announcement the following day; it is expected to sit on its hands. Although, of course, investors will be interested in Governor Mark Carney’s opinions on Brexit, its potential consequences and how the bank will react. The Bank of Japan (BoJ) will be releasing its policy on Thursday as well. Most investors expect no change from the BOJ, but it could surprise by unleashing further monetary loosening. The yen has been weak recently (a departure from stubborn strength over the past few years) which could stay the BoJ’s hand or be traders anticipating more stimulus. Especially given the last week’s announcement by the European Central Bank (ECB).

As a farewell gift, ECB boss Mario Draghi cranked up the money printers once more. The central bank has been buying up tens of billions of euros of debt each month to reinvest maturing bonds from the pile amassed during years of quantitative easing. That kept the ECB’s stack of bonds steady at about €2.65 trillion; from November, the ECB will be adding €20 billion to its pile of assets each month. That’s not very large at all, in the grand scheme of things, but it has no end date, which is a punchy statement. As was his calling out of Germany as being part of the eurozone’s economic woes through their miserliness. The country’s fiscal rectitude is as widely renowned as it is deeply embedded in the nation’s psyche. But on a national level, tight purse strings have started to eat away at its infrastructure. On a multinational level, it has kept the euro artificially high, inflation languishing and stymied demand that could help southern debtor countries work their way out of economic peril. Mr Draghi pleaded that, with interest rates in the Upside Down, it was “high time for fiscal policy to take charge” of the European recovery.

Whether that plea is answered will have massive ramifications for Europe.
 

Bonds

UK 10-Year yield @ 0.76%
US 10-Year yield @ 1.90%
Germany 10-Year yield @ -0.45%
Italy 10-Year yield @ 0.87%
Spain 10-Year yield @ 0.31%

 

Economic data and companies reporting for week commencing 16 September

 

Monday 16 September

UK: Rightmove House Prices

US: Empire Manufacturing

Final results: City of London Investment Trust, M J Gleeson

Interim results: Spire Healthcare

 

Tuesday 17 September

US: Industrial Production, NAHB Housing Market Index

EU: ZEW Survey

Interim results: Hochschild Mining, Smart Metering Systems

 

Wednesday 18 September

UK: Inflation, House Price Index,

US: Fed Funds Rate, MBA Mortgage Applications, Building Permits, Housing Starts

EU: CPI, Construction Output

Interim results: Accesso Technology, Pendragon, Walcom

 

Thursday 19 September

UK: BoE Rate Decision, CBI Trends, Retail Sales

US: Current Account Balance, Existing Home Sales, Philadelphia Fed Business Outlook, Leading Index

EU: Current Account

Final results: Clinigen, Wilmington

Interim results: Allied Minds, Next

 

Friday 20 September

US: Household Net Worth (Q2)

EU: Consumer Confidence

Total votes: 15

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