International conflicts are at the forefront of news headlines in recent weeks with Hamas/Israel tensions seemingly rising each day. Additionally, the Russia/Ukraine war now enters its 21st month and China and Taiwan relations continue to be strained. Regardless of the classification of war or conflict, these events can have meaningful impact on global economies and markets whether they last days, weeks, months, or years.
Oil prices are almost always the first affected. A majority of conflicts have led to a rise in oil prices with potential supply disruptions or demand concerns due to regional instability. The graph below shows how the price of oil has changed in response to various events over the last five decades.1
Oil prices have declined from the most recent peak in 2022 based on the ability of oil producing nations (ex-Russia) to meet the demand. Additionally, the most recent conflict between Hamas and Israel has only seen a very small increase in oil prices since October 7th.
As the chart reflects, there is very often a reaction in oil, and usually that reaction is a spike upward. The data also tells us, however, that conflicts don’t necessarily lead to long-term elevated pricing and often global oil prices can revert quite quickly.
Whether these conflicts last a day or a year, rising oil prices typically lead to higher costs at the gas pump. This can directly affect the American consumer’s pocketbook and, in turn, the US economy. Increased gas prices often act as a tax on consumers, considering the need for travel and commuting rises without any change in behavior or benefit. It is likely that the more consumers pay for gas, the less they will spend on other goods and services.
The picture below from the American Petroleum Institute shows the cost breakdown of a gallon of gas. It shows that 50% of that cost of a gallon of gas is coming from oil, while the remainder includes the need for processing and distributing gas, as well as taxes that are added on.2
As a result, the Federal Reserve must keep a close watch on how oil and gas prices are fluctuating because sustained higher oil prices could lead to inflation above the Federal Reserves mandated target of 2%. Currently, the Federal Reserve has raised interest rates to fight the heightened inflation we have been experiencing since 2022. If oil prices begin to rise from the Israel/Hamas conflict coupled with other economic events, this could lead to the Federal Reserve raising interest rates further to combat inflation. Because of the volatile nature of oil and gas prices, however, the Federal Reserve often excludes energy from their discussions and actions around inflation.
International conflicts, whether the U.S. is involved or not, can have an effect on the US economy. Oil prices tend to react to these events and set off a chain reaction that can lead to potentially lower consumer spending and higher inflation that could lead to rising interest rates. These conflicts, however, are very difficult to predict and outcomes can be wide ranging and unexpected. Therefore, building a long-term investment thesis on the reaction to geopolitical events is, in our opinion, not a strategy that has a lot of merit. As a result, we will continue to monitor the Russia/Ukraine war and the tensions between Hamas and Israel and other potential conflicts and assess the implications they could have on our economy and we will communicate any changes in strategy.
Posted here by Tyler Ellegard, CFA