„Geography is the only art in which the latest works are always the best„.
It is not certain that Voltaire would have said the same thing about geopolitics and, above all, about all the more or less enlightened considerations it is currently generating in the financial markets. For although the geopolitical dimension has never been so overwhelming, the reality of its impact, particularly on the bond markets, is paradoxically limited. This is clearly less the case for equity and currency markets. Jean-Pierre Petit discusses this at length in his analysis.
It should also be noted that the energy and commodities markets are special cases, as there has always been an energy geopolitics with which the financial markets are almost organically associated. Russia’s invasion of Ukraine last year, which changed the geography of most European countries‘ gas and oil supplies, had an immediate and violent impact on the commodities markets.
A crisis with little impact on bonds
On the bond markets, by contrast, the return of a major war to Europe on 24 February 2022, for the first time since 1945, was a minor event.
It is true that yields took a bit of a hit: 25 bps, on the very same day, on the 10-year US Treasury and on the German benchmark for the same maturity. A rather unspectacular flight to quality. And even then, it only lasted a few days. T-Note and Bund yields rose almost immediately afterwards. Why did this happen? The expected effects of Russia’s aggression on the bond markets did not have time to develop: they were entirely swept away by the US central bank’s decision on 15 March to raise its key rates, initiating the fastest and most aggressive cycle of global monetary tightening for over forty years.
Jerome Powell and Christine Lagarde have in fact weighed much more heavily on the bond markets than Vladimir Putin and his tanks.
A market with its own rules
We cannot even pretend that the sharp acceleration in inflation that justifies this change of monetary course is a consequence of the conflict in Ukraine. Inflation was already well outside the range tolerated by central banks, but up until autumn 2021, they were hammering home the message that the phenomenon was transitory.
To put it another way, the specific context of the bond market, marked by a paradigm shift in global monetary policies, was and still is, over-determining. The current resurgence of pressure on global long-term yields, in the midst of an acute geopolitical crisis in the Middle East, and contrary to the traditional flight-to-quality effect, stems from the same idea.
The prospect of a rate cut recedes
More specifically, the rise in long-term rates in Europe and the United States (almost 5% on the 10-year T-Note during the week of 16 October, the highest since 2007) reflects a profound change in the markets‘ perception of the length of the pause that central banks should observe before cutting their key rates again. This change in perception, rather than geopolitical tensions, is also reflected in the stock market correction since the turn of the summer, and in the dollar’s current strength against the major currencies.
Loss of sensitivity to external events
The market context can in fact be analysed as a weaning phase after the long period of dependence on zero interest rates. The effects of this desensitisation cure seem to have considerably reduced the markets‘ ability to react to any exogenous considerations. Even to a major war waged on European soil by the world’s second largest nuclear power, or to a sharp rise in the risk of open conflict between Israel and Iran.
The impact of a major geopolitical event on the markets should therefore be measured first and foremost in terms of the financial context in which it takes place, and not in terms of the shock effect it produces. This observation flies in the face of a deeply held common belief, but one that is belied by the facts. Even an event as powerfully destabilising as the series of attacks on 11 September 2001 did not trigger a massive fall in US yields: 4.83% on 10 September on the 10-year maturity, 4.55% at its lowest 4 days later, and then yields almost back to their starting level.
Central banks’ huge influence
The considerable role played by central banks since the 2008 financial crisis has further strengthened the markets‘ immunity to external hazards. However, this has not meant that episodes of intense volatility have become less frequent. In fact, they have increased on the bond markets, particularly over the past year. Above all, they have changed in nature, with the explosion in intraday volatility due to the intensity of monetary tightening. In 2022, central banks will have completed two-thirds of their programme of forced rate hikes. The gradual fall in bond volatility in the first half of 2023, and the surprising rise in equity markets, reflected the hope – dashed after the summer – that the rate peak had been reached.
Then there is the opposite case, where the markets are largely fantasising about the effects of real geopolitical changes. As in the case of the Global South. The opening this year of the BRICS club – recycling 2.0 of the Non-Aligned Group – to six new members (Iran, Egypt, Saudi Arabia, the United Arab Emirates, Argentina and Ethiopia) has given rise to a deluge of prophetic comments about an imminent shift in the centre of gravity of the world economy as a result of the reconstitution of a bipolar and heterogeneous Cold War-style international system.
However, this heterogeneous syndicate of interests, united solely by a rejection – sometimes opportunistic, sometimes profound – of the Western powers, cannot be likened to a homogenous, coherent bloc. Unlike the European Community (at least in its early days), this group is not driven by a common project. Adding up the GDPs of its members therefore makes no sense. Nor does it suggest that the dollar is losing influence. The US currency still accounts for 60% of central bank reserves, 42% of SWIFT payments (2.4% for the renminbi) and 80% of trade (excluding intra-euro zone trade). The conditions for a significant change in the current regime are still far from being in place.