Oil, bonds and gold consolidate gains as Middle East teeters

Market attention has turned firmly to the likely Israeli ground invasion of the Gaza Strip and its implication for crude supplies from producers in the world’s top oil region. An invasion could propel prices to $US100 a barrel and deal a fresh blow to the global economy’s soft landing.

“The scenario with the highest risk premium for oil prices is one where i) Israel occupies the Gaza Strip to root out Hamas, ii) Israel then turns their attention to Iran, and iii) Iran‑backed militant groups open up multiple war fronts with Israel (i.e. Lebanon and Syria) as soon as Israel’s ground assault of the Gaza Strip begins,” outlined Vivek Dhar, a mining and energy commodities analyst at Commonwealth Bank.

He said direct engagement between Israel and Iran would mean the possibility of conflict in the Strait of Hormuz, the narrow waterway controlled by Iran which accounts for up to 20 per cent of global oil transit.

In August, world crude stockpiles dropped to their lowest level since 2017, so any disruption could propel already high prices and resurrect inflation concerns.

The Organisation of the Petroleum Exporting Countries and its allies, known as OPEC+, warned of steep production cuts this quarter, before the Middle East conflict erupted.

“We believe the oil price warrants a risk premium of $US5 to $US10 per barrel due to the supply risk, and maintain our short-term price target of $US100,” said Daniel Hynes, a senior commodity strategist at ANZ.

Pump contagion

The surge in the price of oil caused petrol prices in Australia to jump above $2 a litre. While the Reserve Bank generally looks past month-to-month volatility in petrol prices, higher oil costs push up underlying inflation over the medium term as businesses pass their costs on to consumers.

Annual core inflation, the RBA’s preferred measure, was 5.9 per cent in the second quarter, well above the central bank’s 2 per cent to 3 per cent target. Third-quarter inflation figures will be released on October 25.

Investors also sought the safety of bonds amid the unease around the MidEast. The US 10-year bond yield fell to 4.66 per cent, inching from a 16-year peak of 4.89 per cent. Australian bond yields drifted lower, with the 10-year return at 4.47 per cent.

“US 10-year Treasury yields seem to be taking a breather from what had seemed an unrelenting march towards 5 per cent,” said Robert Carnell, regional head of research at ING.

“It is hard to be sure whether this is just a pause in that journey, or whether the ‘Fed has peaked’ view is now the prevailing force on yields, bolstered by rising risk aversion due to Middle East tensions.”

Bond traders expect the Federal Reserve to keep rates on hold in November and place just a one-in-three chance of a tightening in December.

In Australia, financial markets imply about a 50 per cent chance of a cash rate increase to 4.35 per cent by May next year.