The armed conflict between the coalition, headed by the U.S. and the Yemeni Houthis, is widely known. It has led to enormous volatility in financial markets, but will it have a long-term impact?
The importance of the Red Sea for the global economy can't be overestimated. Nowadays, it's the shortest and the cheapest trade route between Europe and Asia. According to the Joint Statement of the White House, around 15% of global maritime trade went through it until the Houthis started to attack commercial vessels in November 2023.
The Houthis, who initially targeted ships associated with Israel, are attacking vessels from other countries, namely those that support Israel. This is forcing large shipping companies to change their routes from the Suez Canal to the Cape of Good Hope, increasing freight and transportation rates. For example, from the end of October to the end of January, the Shanghai Containerized Freight Index (SCFI), one of the leading container indices used to assess global trends, surged by over 1,000 points.
Financial markets experienced enormous volatility due to the high levels of uncertainty. In March 2024, tensions are still high. Let's take a look at what is happening to the markets today and what analysts say about the effect of Red Sea tensions in the long run.
Note: the conflict influences different industries and markets, but we look at those affected the most: oil, equities, and Forex.
Oil
According to the latest U.S. Energy Information Administration (EIA) report, in the first half of 2023, the transportation volume of oil and petroleum products through the Bab el-Mandeb Strait reached 8.8 million barrels per day, which is 12% of total seaborne-traded oil.
The attacks led to a dramatic cut in oil flow volume via the Bab el-Mandeb Strait. According to the U.S. Energy Information Administration (EIA) report, in December 2023, it decreased by 18% compared to the January–November 2023 average. The transportation of clean petroleum products fell by 30% in December compared to the rest of 2023.
It was predicted that the conflict in the Red Sea would cause an increase in prices of Brent and WTI crude oil as the supply was disrupted. Companies needed to reroute their ships, which led to a rise in the time of shipment and additional costs. In December 2023, the volume of oil passing to Europe from the Middle East halved to about 570,000 barrels per day, compared to 1.07 million barrels per day in October.
However, both Brent and WTI formed medium-term downtrends. This might happen because the market was sure there was too much supply in the world to worry about the lack of oil. The U.S. produced record volumes, while Europe had enough natural gas for the winter. At the same time, analysts stated that weak oil demand was due to a warm winter and China's economic problems. Moreover, rumors that the Houthis would unlikely attack ships of politically friendly countries like Russia and Qatar lowered the fear of reduced supply.
The situation changed quickly. The conflict continued with no certainty as to when it would be resolved. Also, OPEC+ countries couldn't allow prices to keep falling. As a result, the trend changed. From the end of December to the middle of March, Brent and WTI prices went up, supported by OPEC+ production cuts and problems with redirecting cargo from the Red Sea.
However, it's too early to talk about the strength of a new uptrend. According to analysts, the conflict benefits oil prices but won't trigger a spike. Moreover, conflict resolution may bring vessels back to the Red Sea, facilitating supply and putting pressure on oil prices again.
Shares
The stock market, known for its inherent volatility, has seen an increase in fluctuations due to rising tensions in the Red Sea. These developments have led to heightened volatility across a broad range of industries, extending beyond just the oil and gas sectors. International retailers and car manufacturers, among others, are facing challenges such as shipping delays, rising costs, and consumer dissatisfaction. In contrast, the shipping industry stands to benefit from the situation, as geopolitical tensions contribute to increased tariffs and shipping fees, generating a positive impact for carrier companies.
Forex
Red Sea tensions bear a risk not only for equities and oil but also for the world's economy and the Forex market. The Organisation for Economic Co-operation and Development (OECD) consists of 38 of the world’s largest economies, including the U.S., U.K., and European countries. It claims that shipping costs could hinder the global fight against inflation. OECD forecasts that costs could add 0.4% to overall price growth for the year.
Global economies, including the U.S., the E.U., and the U.K., have to postpone interest rate cuts due to high inflation. Therefore, this may be a risk for their economies but a good sign for domestic currencies. High-interest rates usually lead to a country's currency becoming stronger. However, the situation isn’t that simple. Markets may have already priced in a few rate cuts this year. Therefore, higher inflation may have a limited effect. Moreover, the OECD admits that the conflict in the Red Sea is just a risk but not what they believe to be a real threat. Moreover, the chief economist at OECD, Clare Lombardelli, admits that the conflict in the Red Sea is just a risk but not what they believe to be a real threat.
Another factor that can affect Forex is global market sentiment. News related to the success of the coalition headed by the U.S., which includes the United Kingdom, Italy, and France among others, may have a positive impact on the US dollar, British pound, and euro. The strength of the Houthis may put pressure on these currencies.
Still, the effect of both events is likely to be short-term. Tensions aren’t the only driving factor for the Forex market. Many aspects, including economic indicators and countries’ monetary policies, may have a greater impact on the currencies.
Final Thoughts
The armed conflict in the Red Sea undoubtedly has a strong negative impact on financial markets and bears risks for the global economy. However, the influence may not be that strong in the long run.
According to the Octa analyst, although the tensions in the Red Sea have already caused plunges and surges in the financial markets and may cause undesirable consequences for the global economy, the actual impact will depend on numerous factors, including other geopolitical tensions and global economic conditions. Traders should keep watching the factors that may affect the markets.
Although the tensions in the Red Sea have already caused plunges and surges in the financial markets and may cause undesirable consequences for the global economy, the actual impact will depend on numerous factors, including other geopolitical tensions and global economic conditions. Traders should keep watching the factors that may affect the markets',—said Kar Yong Ang, Octa's financial market analyst.