Three markets we’re watching

0:08Pushkin. War has erupted in the Middle East. The surprise attack on Israel over the weekend is clearly the main story in markets news and news just about everywhere. And investors like everyone else are trying to figure out what it means. Today on the show, three markets that we're watching that might tell us something about it. This is Unhedged, the markets and finance show for the Financial Times and Pushkin. I'm reporter Ethan Wu here in the New York studio, joined as ever on Tuesday by FT Markets editor Katie Martin in London. Hey, Katie. Hey, Ethan. How are you going? Well, I think like everyone else, I was just glued to the news this weekend trying to figure out what was going on, which seems to be what investors are doing too.

0:47And we want to get into three markets that might help us make sense of what we're seeing in the news. And those markets are oil, gold, and the Japanese yen. And I think the broad thing these all share is these are haven trades. These are trades that you fly to when things get scary in the market. Yeah. Markets are kind of funny they have a certain muscle memory and when you get economic shocks or geopolitical shocks but particularly geopolitical shocks like the one we've seen over the weekend there are just certain markets that are go-to that they just perform well in moments of geopolitical crisis and you know the Japanese yen is definitely one of them the oil price is one because of where this this conflict is taking place right in the Middle East and and there's gold.

1:36There are other things as well, but these are some of the really important assets that you look to to get a sense of just how nervous investors really are. So like you said, Katie, any conflict in the Middle East is going to kind of push investors' minds immediately to what's going on with oil. Obviously, the Middle East remains kind of a key global supplier of crude. And we have kind of a recent precedent for a geopolitical conflict causing a big run-up in the oil price, and that's the war in Ukraine. Russia, like the Middle East, is a major exporter of oil as well as natural gas. And in the wake of that war, we did see a pretty significant increase in global energy prices.

2:11And so, you know, I think like everyone else in markets, after I started reading the news of what was going on in Israel, I took a look at what oil futures were doing. And it's not like they didn't move, but it didn't seem like much. Yeah, I would not have been at all surprised to have come into work on the Monday and found that oil was trading at over$100 a barrel, frankly. But that's not what's happened at all. And I think it's worth sort of zooming out a little bit and talking about just how weird oil has been recently. So we had a massive rally in oil prices from around sort of late summer.

2:43I think prices came up something like 25%. And all of a sudden, you start hearing analysts talking about, okay, we're going to get$100 a barrel oil again, we're going to get$150 again. The reason for that is not that the economy is kind of firing on all cylinders, and you've got this kind of huge run up in demand for oil is because Russia and Saudi Arabia, the kind of really big dogs of the oil market, decided to restrict supply. And the less kind of oil they're providing onto global markets, the higher the price goes. They wanted to support the oil price. And so that's what pushed the oil price up over the summer.

3:19You can contrast it with, for example, the copper price to tell you that this isn't a kind of global demand story. This is just about the supply being constrained. So we saw a big run up in the oil price. And then that actually sort of collapsed under its own weight a little bit last week. It just got to the point where the market started to say, okay, we think this is actually going to become a problem for global growth. And that kicked the oil price a little bit lower last week. Now what we're finding is we've got this issue that sprung up in Israel. And, you know, as you say, anything in that part of the world that is geopolitically stressful, is generally supported for the oil price.

3:55But it's fighting, if you like, against that kind of recent price action that we've seen in the oil price. And so we've seen oil pick up, but it hasn't gone through its recent highs. Exactly. And I think people in just in recent weeks in oil markets have been more attentive to that global growth story too. Is Chinese demand going to fully restart? Is there going to be a recession in Europe? Is US growth heading for a slowdown in the fourth quarter? these are becoming kind of more top of mind for people trading oil and consumers cannot bear oil prices to infinity, right? Like there's a point at which higher oil is responded to by consumers cutting back.

4:30And that is ultimately bad for oil. That ultimately results in a lower oil price. And so we're having, like you say, Katie, this geopolitical shock at the same time that oil's in a little bit of a downtrend. And I think another part of it is that the scale of the supply disruption is not exactly clear yet. It's obviously early days and things are moving quickly. So there may be things that we've missed, but I've only really seen one major disruption, which was this like Chevron controlled offshore production facility that has production being halted. That's not a gigantic supply disruption as far as I can tell.

5:03And so I think until the scale of the disruption is clear, which is going to depend on a lot of factors that are unknowable right now, like what was Iran involved in this conflict somehow? Does it spiral beyond kind of the current boundaries of the conflict. Investors, I think, are sensibly waiting to see. They are waiting to see. And this will have kind of global market implications from the point of view that central banks are kind of hopeful that they've started to get inflation under control. If we see a massive run up in the oil price, reasonably big if, but if we do, then that could complicate the inflation picture across the US and Europe and everywhere else.

5:39Yeah, that's oil. And now I want to talk about the yen, which is kind of this classic haven trade. But Katie, maybe you can talk about why, right? Isn't it kind of weird that like, things get hairy and people run for the hills in Tokyo? It just seems odd. It is odd, right? So your classic currencies to perform well in times of geopolitical stress are the dollar. Can't get away without talking about the dollar at all, right? So, So, you know, you saw this in March 2020. You know, you've seen this on all sorts of different occasions. The dollar is a classic kind of haven trade. The Swiss franc, if you know, if you want to put your money somewhere in a nice safe hidey hole, then Switzerland is a good place to do it.

6:19So these things are generally quite beneficial for the value of the franc. But also the yen. Now, this is a bit of a weird one, right? Because everyday people have, you know, outside of Japan have banishingly little use for the Japanese yen, right? In reality, it's just it's not a global currency in the way that the dollar is or even you could argue the Swiss franc. But what generally happens is that when Japanese investors get some sort of shock, Japanese investors are actually really they're big investors in overseas assets. And when they get some sort of shock, they tend to bring that money home.

6:51And so the yen tends to rise in times of stress. And sometimes that's, you know, really unwelcome because no one wants their currency to be too strong. So even though global investors have little use for the yen, people piggyback on that move, if you see what I mean. So because there's this muscle memory that, OK, bad things happen, yen rises, the market tends to try and get ahead of that and pushes it up further. So one example that sort of really springs to mind here is when there was the terrible earthquake and tsunami in Japan in 2011. One anecdote that somebody told me once was that, you know, the international community came together and said, you know, what can we do to help Japan?

7:31You know, could we perhaps, some European official apparently said, maybe we could buy some Japanese bonds. Because at the time, the thing that Europe needed more than anything else was international support for its bond market. So they thought they were being helpful and saying, maybe we could buy some of your bonds. And the anecdote at least goes that Japanese officials were like, please don't do that. The last thing we need is for the yen to get even stronger than it already is. If anything, it would really help us out if you could weaken the currency because we've got too much yen strength.

7:59This is like back in 2011, a whole different age, right? So this is just what the yen does when things spook the market, when the market gets nervous about any kind of geopolitical conflict, the yen normally rises. We're not seeing that so much this time. We can kind of talk a little bit about why, but that's definitely one of the things that is a go-to thing to look for. I've got to ask you just out of curiosity, what were you up to in 2011? Writing about the yen. I'm a very boring person, Ethan. I only do one thing. I think I want to bring it back to the idea of being cross-pressured, right?

8:33And we've talked about this on the show. Japan is undergoing this potentially transformative story. But one element of that is the central bank does not want to kill off the emerging growth and inflation story in Japan by tightening monetary policy too soon. So they are the last country, really, to keep rates super low, potentially negative. Yeah, they're 10 basis points. So that's 0.1 percentage point in old money below zero. Yeah, they're still in the deep freeze. It's amazing. Exactly. And that exceptional monetary policy stance in a world where every other central bank is at 4%, 5%, 6 % interest rates, that puts incredible pressure on the yen, downwind, because investors tend to like currencies that yield a little bit more.

9:16You can get an easy return on your safe currency cash investments without taking much risk. And if you're a currency that does not offer particularly much yield, that incentivizes people to move away from your currency. And we've seen in the past couple of years, just a persistent downtrend in the yen. Massive. Yeah. Absolutely huge. I think it's the weakest it's ever been. Oh, it's right up there. Dollar-yen is trading at like 150. So you get 150 yen for your dollar. That's a lot. I am embarrassingly old enough to remember when the authorities were intervening to stop that rate hitting something more like 70 or 80.

9:50So yeah, massive downdraft in the yen. And it looks like for now, the markets are nervous, and we don't know what's going to happen next in the Middle East. That's really kind of knocking heads with that macro force. And it means that it's really stopping the yen from jumping here. Yeah. It could potentially be a drop in the bucket if this is a conflict that does not have broader global market implications. And we're in the middle of this kind of secular downtrend. In the end, that has even invited the government to intervene in the market. I think investors would be wary about buying this too aggressively as a haven trade at this particular point.

10:24Yeah. The government keeps kind of threatening to come in, right, and do something to actively strengthen the currency, which is super unusual for Japan. They're not an intervention point quite yet, but it might be that geopolitics could do part of the job for them if it does end up pushing the end that little bit higher. Yeah, we'll have to see. And the last haven trade we wanted to talk about is gold. And this is your sort of classic geopolitical risk-off asset. Gold, thousands of years of history is a store of value, yada, yada, yada. I don't want to sound like a gold bug here. But again, to bring it back to Ukraine, after that war erupted, you did see an increase in the gold price.

11:04It wasn't enormous, necessarily. There was a much bigger flight to gold after the inflation episode of 2021 began. But you did see some risk-off behavior toward gold. And this time, you've seen a little bit, too. But it's been pretty de minimis, like 1 % or 2 % maybe in the gold price over two trading days. Yeah. What we're not seeing yet is a really explosive jump in the gold price. And it's been months since anyone has even mentioned gold to me you know it was kind of you know the classic kind of oh you know we're nervous about the fiat currency system and the institutions that keep markets ticking therefore i'm going to you know hide in the gold market that whole narrative kind of died down and got sucked away i think largely into crypto and crypto is dying back and so gold i guess is having a little bit of a kind of resurgence of interest not that much so far on price.

11:55But yeah, the gold bugs, they've got back out of their box. They're making some noise again, but it's not immediately obvious that what we're seeing so far in terms of this geopolitical shock is enough to really send gold rocketing higher. Yeah. And I got to bring it back one more time to this idea of being cross pressured because one of the fundamental determinants of the gold price is the real interest rate, right? This is kind of like the deep economic variable underlying a lot lot of assets, but this is the rate of interest you can earn on a risk-free investment after you adjust for inflation.

12:28The risk-free rate has been going up. We've talked about this on all of the last couple of shows that long treasuries yields are surging just as inflation is moderating a bit. That pushes the real yield up. When the real rate is higher, that creates a higher opportunity cost for gold. Gold is like a rock. It just sits there. It does not yield you anything. You don't get an additional 5 % of gold for holding gold in your safe or whatever, it's a zero yield investment. And so when the prevailing inflation adjusted yield goes up, gold becomes less attractive by comparison. Again, like with oil and like with the yen, there is this broader kind of force pushing against any tendency to surge into gold because the world's gotten scarier overnight.

13:11Yeah. Gold doesn't pay you a dividend. It doesn't pay you interest payments. So it's very much in direct competition with yields on government bonds. And yeah, I guess this is where a lot of this comes down to, right, is that there's a big uncertainty over how the situation in the Middle East is going to pan out. And so investors don't want to kind of, you know, jump first and ask questions later. But the other thing is that to the extent that there is nervousness around all the things we've spoken about, that is absolutely running counter to the big macroeconomic shifts that are lifting bond yields and suppressing the oil price.

13:46So it's quite a messy picture. And there's a lot of big forces kind of pushing against each other in the next few weeks, I guess, will tell us which is going to prevail. Yep. And at the end of the day, as a friend of the show, Robert Armstrong, wrote in today's Unhedged Newsletter, markets are just not very good judges of geopolitics. They're not necessarily the best judge of geopolitics or even of economics half the time. Yeah, well, with that dig against Mr. Market, we'll be back in a moment with Long Short.

14:26Welcome back. This is Long Short, that part of the show where we go longer thing we love, shorter thing we hate. Katie, are you long something or short something? I am long training. So humble brag, I did the Royal Parks half marathon at the weekend. The reason this isn't quite a humble brag is that I ran it extremely badly. The reason for that is I had not trained properly for it. And so I'm here to be that person tapping you on the shoulder when you sign up for a half marathon that says, you know, you have to train for this, right? You can't just like turn up because you're going to find it extremely unpleasant.

15:03So it's a long way. You need to train for these things. I'm long training. And I think especially with a half marathon, you see the word half and you think, well, how hard can it be? It can be hard. Yep. That is for sure. Well, Katie, I am sure private equities expected returns in the next five or 10 years. We've been writing about this on the Unhedged newsletter and talking to various folks. People predict like a private equity meltdown crisis, et cetera, et cetera. I don't know if I'm a big believer in that, but I do think private equity has set a really high bar for the returns they're supposed to deliver.

15:34And they're increasingly being put subordinate in the capital stack to private credit lenders that we talked about on the show who are extremely sophisticated. And I think as defaults start to pick up, which they should in the next couple of years, take up at least a little bit, you're going to see some pretty ugly legal clashes between private equity and private credit. And I think at the end of the day, we should start to expect some pretty disappointing private equity returns in the next couple of years or so. I could be wrong. They're very smart people. I don't want to undersell how good they are at their job.

16:05But there are sometimes these structural corrections in the market. And I think this might be one of them. And if there are some good legal clashes, I am long popcorn. Yes. All right, Katie, thanks for being here. We'll have you back next week. And listeners will be back in your feed on Thursday with another episode of Unhedged. Catch you then.

16:29Unhedged is produced by Jay Carper and edited by Brian Erstat. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Jacob Weisberg, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.