(Bloomberg) -- Surging oil prices are forcing investors to rethink their strategies to factor in the potential for a prolonged period of sky-high energy costs.
A sustained jump in crude increases the prospect of a global recession and a return to the stagflation seen in the 1970s, where inflation runs hot but there’s no underlying economic growth. Central banks will also find their options limited as rising prices crimp their ability to maintain stimulus.
“Everyone is watching oil, the broader market moves are flashing that the risks of stagflation are incredibly real and things could get a lot worse from here,” said Shyam Devani, technical strategist at SAV Markets in Singapore. “And this time, the rescuers during the pandemic -- central banks -- are almost powerless to tackle the problem. Investors are on their own.”
The impact of the oil rally caused by the war in Ukraine cascaded across financial markets Monday, showing how widespread its impact will be. Stock markets have been pummeled on the outlook for deteriorating corporate earnings, European currencies have been sold off due to their dependence on Russian oil, while Treasuries -- usually the haven of choice -- have been restrained by concern of rising inflation.
As Brent oil surged to approach $140 a barrel, the highest since 2008, traders piled into options that it could rise above $200 before the end of March.
Read More: What a Ban on Russian Oil May Mean for an Already Chaotic Market
Lombard Odier’s Homin Lee recommends taking a defensive position due to the correlation between oil price surges and U.S. recessions.
“The signals are pretty clear about rapidly rising risks of a recessionary outcome globally,” said Lee, an Asia macro strategist in Hong Kong. “The consensus is shifting from a hard war that’s ending quickly to more protracted conflict. Bonds rallying, commodities strengthening and equity markets taking hits. This is basically an expression of recession fear.”
Fear Flight
The flight from risk is plain to see across markets in hours of frenzied trading on Monday.
S&P 500 futures dropped more than 2%, the Stoxx 600 declined 3.8% while Asia’s regional benchmark was poised to enter a bear market. The U.S. equity gauge may drop to 4,000 by the end of 2022 -- a fall of some 8% from current levels -- according to Yardeni Research, which last month had a target of 4,800.
Hamish Pepper at Harbour Asset Management says the risk of recession means investors may want to return to fixed-income given how much yields have risen recently.
“Markets are telling us that the damage to economic growth globally, and particularly in Europe, will be profound,” the Wellington-based fixed-income strategist said. “Yields have risen from the lows we’d seen following Covid. It’s got more merit in portfolios now, particularly in these moments of crisis, than in the lows of 2020.”
Haven Doubts
The playbook for bonds though is fraught with risks. Investors must decide if haven bids fueled by the war in Ukraine outweigh the impact of accelerating inflation. At the same time, the Federal Reserve has signaled it will raise rates from this month.
Benchmark Treasury 10-year yields have dropped almost 35 basis points from the high of 2.06% reached in February, but that remains well above the level of 1.13% reached in August.
Others are recommending investors put money into one of the most traditional haven assets: gold.
“The risk of a recession is very high: buy bullion, just buy bullion,” SAV Markets’ Devani said.
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