How should investors navigate geopolitical risks in early 2024?
Samy Chaar, Chief Economist
Christian Abuide, Head of Asset Allocation
Key takeaways
- Rivalry between US and China-led blocs, possible Middle East conflict escalation and a busy political calendar keep geopolitical risks elevated as we enter 2024
- We still expect the Israel-Hamas conflict to remain largely localised. Red Sea attacks are affecting trade but should have a manageable inflationary impact. We expect oil prices to drift up towards the low-end of a USD 80-90 a barrel range, with short-lived price spikes possible in an extreme scenario
- A global ‘decoupling’ is changing global trade and investment flows. Securing supply chains and strategic industries has become an important theme
- We believe 2024 should be a positive year for financial markets, but remain vigilant in an uncertain geopolitical environment. Tactically, we keep portfolio risk at strategic levels, with a quality bias and a preference for US assets.
With tensions rising around the Red Sea, how do we view geopolitical risks in the early months of the year, and how are we navigating them in client portfolios?
This year, geopolitical fault lines threaten to create further shocks in a fracturing world. Intensifying rivalry between US and China-led blocs is reshaping global trade, supply chains and investment flows. Several geopolitical flashpoints are high in investors’ minds as we enter 2024, including in the Middle East, Taiwan, and Ukraine.
Despite elevated US-China tensions and multiple conflicts globally including the Israel-Hamas war, risk assets rallied strongly in 2023, especially in the final quarter. Geopolitical risks remain high in early 2024, with a focus in the Middle East. The year ahead also promises an unusually busy political calendar, including US presidential elections, and ballots in countries including the UK, Japan, Europe, India, Mexico, Turkey, Venezuela, South Korea, South Africa, Iran, Russia and Ukraine.
Middle East escalation risks
Since the start of the Israel-Hamas war and Russia’s invasion of Ukraine, our view has been that both conflicts would largely remain localised. A key concern now is whether conflict in the Middle East will escalate, given Houthi attacks in the Red Sea and Gulf of Aden and US-led retaliation, Iranian missile attacks and seizure of an oil tanker off the coast of Oman, and rising tensions between Israel and Hezbollah. Such actions have not altered our working assumption. This is in part due to the high stakes involved in conflict escalation for global trade, oil prices and major economies, one reason behind intense US diplomatic efforts. Of course, rapidly moving events require sustained vigilance. Yet absent a broader escalation, we note that the past 25 years of turmoil in the Middle East have had limited impact on global growth and financial markets.
Threats to trade and inflation?
Red Sea attacks are having an impact on trade. They have rerouted container shipping from the Suez Canal around southern Africa, adding 10-14 days to transit and requiring more fuel. Over 10% of global trade, 12% of seaborne oil and 8% of liquefied natural gas pass through the Red Sea. Cargo ships carrying commodities have been less affected. Freight shipping prices have spiked since the attacks, although far less than during the Covid-related closure of China’s economy. We expect this spike to recede. While there will be near-term impacts for some companies and sectors – including shipping firms and consumer goods – these do not shift our baseline economic or inflation forecasts.
If the Red Sea were to remain closed to shipping over several months, there would be an inflationary effect. If freight costs remained roughly twice their mid-December 2023 levels, the International Monetary Fund estimates annual consumer price inflation rates would be 0.7 percentage points higher by end-2024 on average globally. Given the attacks affect one specific global trade route, we expect the potential impact on goods prices in the eurozone to be roughly twice the size of that in the US. However, this would not be enough to reverse the slowing trend of inflation globally. Nor do we think it would prevent the Federal Reserve (Fed) and other major central banks from cutting interest rates in the first or second quarter.
Oil expectations
Oil prices also reflect geopolitical risks. Attacks on shipping and a Libyan outage due to domestic protests have prevented prices from falling lower in recent weeks. Nevertheless, the Brent crude benchmark has largely stayed below USD 80 per barrel this year, after highs of over USD 90 in 2023. This is mainly due to market surpluses, as supply from countries outside the Organization of the Petroleum Exporting Countries and key non-members (OPEC+) meets most of global demand growth. Non-OPEC+ production, including from the US, has risen substantially. Spare capacity among OPEC+ is near all-time highs and Middle Eastern production has largely been unaffected by the conflict, at least for now.
Of course, prices would spike higher if supply were severely disrupted, either via threats to tanker transit through the Strait of Hormuz, conflict escalation to major Middle Eastern oil producers, or stricter sanctions on Russian, Iranian or Venezuelan output. These are low-probability scenarios in our view, given the high stakes involved. We also think OPEC+ would ramp up production to smooth any major supply disruption.
Weighing high geopolitical risks against slowing global growth and market oversupply, we expect Brent crude prices to trade in the low end of the USD 80-90 a barrel range in coming months. Rising seasonal demand should push prices into the middle of this range by mid-2024. In an extreme scenario where all oil tankers were temporarily forced to avoid the Red Sea, resulting in around 105 million barrels more oil on the water, we estimate it would lead prices about USD 4 per barrel higher.
Supply chain security
Red Sea attacks reinforce the rationale for a key theme in today’s global economy: supply chain security. Major blocs including the US, China and European Union are seeking to secure supply chains, re-route them via allied countries, or in some cases, repatriate and reinforce strategic industries (pharmaceuticals, microchips, electric vehicles) in the national interest. This increases the chance of trade disputes. The Chinese authorities may also see Taiwan’s recent election result as another reason to strengthen its domestic semiconductor industry. Taiwan’s more independence-oriented ruling party (DPP) won the presidency again in elections on 13 January, and we will be closely monitoring Beijing’s response in the weeks ahead.
‘De-risking’ by US- and China-led blocs is reorienting global trade and investment flows (see charts on page 3). Competition between the two is spurring a capital spending boom in defence and green technologies, as well as some duplication and inefficiencies in supply chains. We do not expect such trends to be hugely inflationary, but a willingness to increase government spending is one factor behind our expectation for slightly higher inflation than pre-pandemic levels, and a slightly higher ‘neutral’ interest rate in major economies. From a market perspective, these trends will also contribute to creating winners and losers, both from regional and sectoral perspectives. Vietnam and Mexico are examples of the former; industrials, materials, and semiconductors of the latter.
Meanwhile China’s leaders have much to manage domestically in 2024 with a slowing economy, deflationary pressures, and a property meltdown, which may lessen their strategic appetite for military confrontation. We remain cautious on Chinese assets, with equities and the renminbi facing an ongoing drag, while rates are low but unattractive versus major developed economy alternatives.
As the year progresses, US political risk will intensify. A potential re-election of Donald Trump as US President in November, and the possibility of the Republicans also controlling the House and Senate, could see the re-emergence of disruptive tariffs, restrictive migration policies that re-ignite inflation, and a volatile shift in foreign policy.
Portfolio implications
Thinking across scenarios, how do these risks alter our investment strategy? Our strategic asset allocation is designed for a higher neutral interest rate and uncertain geopolitical environment. It focuses on core portfolio holdings such as US equities, more fixed income in certain profiles and a tilt towards quality across asset classes.
Given risks around geopolitics, slowing global growth, and a potential repricing of the market’s Fed rate cut expectations, we keep portfolio risk at strategic levels. Tactically, our current positioning includes an overweight to US Treasuries and high quality corporate bonds. We also favour US equities, where we think US market leadership and valuation premium can continue, supported by both macroeconomic and sector advantages.
In currency markets, we see some scope for the US dollar to recover ground in the months ahead, given its growth and yield advantages, and traditional role as a haven from geopolitical risks. Meanwhile, we think gold prices could rise to around USD 2,100/oz as the year progresses, supported by geopolitical risks, Fed rate cuts and normalising real rates, as well as strong physical demand. We continue to closely monitor any short-term challenge to our geopolitical assumptions, notably shipping costs and global oil prices. Potential short-term volatility – if market rate cut expectations are repriced further, or from geopolitical events – could offer opportunities for tactically adding risk to portfolios.