A Crude Awakening
March shattered the calm of February’s tight trading ranges with a stark reminder that geopolitical risks can reprice markets in an instant. Simmering conflict with Iran boiled over into a full-scale war in the Middle East.
The conflict effectively closed the Strait of Hormuz, the only waterway between the Persian Gulf and the open ocean, choking off critical oil supply and sending crude oil futures soaring. It’s one of the world's most important energy arteries, with nearly 20% of the world’s oil typically funneling through it. Crude, which had spent much of the past year comfortably range-bound, skyrocketed past the $100/bbl mark, logging its second-largest single-month gain since 1974 (+51.3%).
The spike in oil sent shockwaves across the global financial ecosystem. For investors, the initial instinct was a classic flight to safety, though it didn't play out entirely as expected. Gold, usually a safe haven during times of geopolitical upheaval, sold off instead. (One theory is that emerging market governments heavily exposed to the oil shock sold some gold to buffer the volatility.) Meanwhile, the U.S. dollar reprised its historical role as a leader in times like this, appreciating 2% against a basket of major currencies.
More broadly, risk assets took a heavy hit. As markets struggled to digest the implications of a sustained energy supply disruption, the S&P 500 fell below 6,800 and below its 200-day moving average and other technical levels of support. While Energy stocks outperformed — acting as the primary lifeboat for equity investors in a sea of red — industries that are highly sensitive to fuel costs, such as Airlines and Automobiles, struggled.
The "S" Word Returns
Beyond the immediate volatility in stock prices, the massive spike in crude oil introduced a complex challenge for the broader macroeconomic picture. Higher oil and gas prices act as a regressive tax on the consumer, eating up discretionary income that would otherwise go to other goods and services. And household sentiment was already weak because of sluggish hiring and a challenging housing market.
This geopolitical crisis puts the Federal Reserve in an unenviable position. For much of the first quarter, the central bank was carefully navigating stubborn tariff-induced inflation while facing unprecedented political scrutiny and threats to its independence. Now, the surge in energy prices threatens to push headline inflation significantly higher, effectively taking any near-term interest rate cuts off the table.
Making matters worse, the Fed can’t hike rates to fight inflation without risking a severe recession. By crimping consumer spending, the oil shock threatens to slow economic growth even as inflation rises. This toxic combination has resurrected a word investors loathe: stagflation.
Consequently, we saw a massive bid for inflation protection in the bond market, while corporate credit spreads widened as investors began pricing in the elevated risk of an earnings recession. Stagflation pricing in action. Markets are poised for a bounce on convincing news of a de-escalation, but the longer this drags on, the tougher it will be for investor optimism to recover. Last month’s defensive rotation has quickly turned into a full-scale retreat from risk.
Market Recap
Macro
• Against consensus for 55k jobs added, the February employment report showed 92k jobs lost, one of the largest downside surprises on record.
• Crude oil surged over 51.3% during the month, its largest monthly rise in decades, breaking decisively above $100 per barrel as the Iran conflict disrupted global energy markets.
• Driven by the spike in energy costs, market-based measures of inflation expectations (such as the 5-year breakeven rate) jumped to their highest levels since 2023.
• University of Michigan’s Consumer Sentiment Index fell from 56.6 to 53.3, driven by rising gasoline prices and geopolitical fears.
• Gold fell 11.6% to $4,530/oz, driven by profit-taking and energy-exposed emerging market countries selling it for liquidity.
Equities
• The S&P 500 suffered its worst month since September 2022, declining 5% for the month as equity valuations declined in response to intensifying oil price shock concerns.
• The Energy sector was the undisputed winner of the month, riding the oil shock to finish the month up over 10%, while industries such as Airlines and Automobiles lost nearly 10%.
• The risk-off environment helped boost defensive factors such as Low Volatility, Value, and Dividend Yields into leading positions for the month and year-to-date.
• Dollar appreciation and net energy exporter status helped U.S. stocks outperform emerging markets, which are heavily reliant on oil from the Middle East, by over 2 percentage points.
Fixed Income
• 2-year Treasury yields rose as much as 64 bps through Mar. 27, reflecting an increase in inflation expectations of 35 bps and an increase of 29 bps in the real yield component.
• Treasury market volatility (i.e. the MOVE Index) rose from a value of 73.4 to 112.0, one of the sharpest increases since late 2021.
• High Yield spreads widened by as much as 44 basis points, as investors demanded higher compensation for risk due to the threat of an economic slowdown.
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