This week we are looking at the economic and political forces threatening to undermine global stability. First, we take a look at the big picture of global stability through the lenses of ongoing geopolitical crises and financial turbulence. Next, we continue to track the conflict between Israel and Hamas and the devastating consequences it has had for the civilians caught in the middle. Then, we take a closer look at the financial and political stressors facing Japan and Europe. Finally, we learn about some major opportunities in bonds and what recent bond market movements can tell us about the future.

Political and Economic Instability

The Five Main Drivers of Global Economic Uncertainty

Mohamed A. El-Erian, Project Syndicate

War and Dollars

Harold James, Project Syndicate

With Interest Rates Up, Get Ready for Financial Drama

Jonathan Weil, The Wall Street Journal

The global economy is subject to significant political and financial risks. Politically, ongoing geopolitical crises, such as in Ukraine and Israel, are promoting major instability, while nuclear deterrence and the dollar-denominated system — the underpinnings of the stable, Cold War order — are increasingly becoming unstable. Further, the American public has grown increasingly skeptical of hyper-globalization and hyper-financialization. To rectify these issues, financial stability is key, and the international financial governing order needs readjusting. For instance, financial decision-making could occur in global institutions via simple-majority rules and adjudicated by judicial processes to deal with bad actors.

Meanwhile, global growth is potentially facing significant risk, which can be traced to five factors. First, the global economy’s growth engines are currently under strain and are heavily reliant on the US. Second, the journey toward the future is uncertain, especially as it pertains to how long rates will remain elevated. Third, if high rates stay in place for longer, the risk of financial turbulence is significant; a fact on full display earlier in the year when several regional US banks started failing. This can be seen historically, too, in the Continental Illinois National Bank & Trust bank failure. Fourth, the global economy and key financial markets lack top-down anchors such as growth momentum, confidence in policymakers signals, and stabilizing financial flows. Finally, responses to long-term crises such as climate change have proven inadequate. These problems can be remedied through more inclusive and consistent growth, improved domestic policy, and stronger global policy coordination.

What Does the Future Hold for Israel and Gaza?

How This Israel-Hamas Conflict Is Like Nothing That’s Happened Before

Lisa Beyer, Bloomberg

Israel-Hamas war: 5 scenarios for Gaza’s future

Kersten Knipp, DW

The catastrophe unfolding in Gaza

Editorial Board, Financial Times

The current flareup in the conflict between Israel and Palestine stands out in its intensity and geopolitical ramifications. Around 1,400 Jews were killed by Hamas on October 7, and over 200 were taken hostage. Israel’s strikes on the Gaza Strip have killed over 7,700 and have displaced almost half of the strip’s 2.3 million people. Hamas pledges by its charter to annihilate Israel while Israel has said it intends to destroy Hamas. Neither of these goals is achievable, and both have already wrought unbearable human tragedy. After the horrors of October 7th, destruction has begun to be inflicted upon the Palestinians living in Gaza. Israeli air strikes have destroyed homes, hospitals, and infrastructure while limiting water, electricity, fuel, and food. Around 47% of the population of the Gaza Strip is younger than 18. Israeli forces have recently made a major push into Gaza, and Israeli Prime Minister Benjamin Netanyahu has announced the beginning of the war’s “second stage,” which may prove to be “long and difficult.” An operation of this size is unheard of in recent history – most conflicts between Israel and Hamas have been limited to air strikes between the two parties.

What will happen to Gaza? Israel is not likely to completely eliminate Hamas, but its assault will weaken the group, which has controlled the strip since 2007. There will likely be a massive power vacuum, the perfect environment for other radical Islamist groups to take control. Israel would not want to directly occupy the territory, as it would weaken their international standing even further. A potential civilian authority would be unstable, but perhaps better than the alternatives. While Gaza’s future is uncertain, the Palestinian’s ongoing suffering is not. Meanwhile, violence in the West Bank is rising. A humanitarian ceasefire is necessary to keep the violence from spreading regionally, if, perhaps, Hamas’ patron Iran decides to get involved and halt the suffering of innocent Palestinian civilians. If a humanitarian ceasefire is not implemented and tensions do not begin to fall, the region may be on the brink of destruction – a conflagration that could drag in the rest of the world.

Western Financial and Political Stressors

The BoJ is playing a blinder

Robin Wigglesworth, Financial Times

Europe is still the soft underbelly of the west

Janan Ganesh, Financial Times

The US’ closest post-World War II allies in Japan and in Europe are increasingly under stress. For the Japanese, that stress is primarily financial as the Bank of Japan’s (BoJ) “yield curve control” (YCC) policy – its defense of 10-year bonds at or below 1% yield – appears moribund. To date, the BoJ’s added flexibility on YCC has taken to the markets smoothly. However, in the short-term, speculators may play chicken with the BoJ to determine how hard the 1% line is and induce bond market volatility, while in the long-term testing the BoJ’s willingness to make large purchases, lest carnage ensue.

The Europeans are similarly at an inflection point, though theirs is not discreet to the economy and has political dimensions as well. At present, the European states are fragmented and weak and reliant on America and American engagement. Given economic weakness among the big players, the EU appears unlikely to emerge as a guarantor of its own security. On the part of the UK and France, both are overburdened with public spending, while Europe’s other big player, Germany, recently had its business model predicated on cheap gas and strong Chinese exports go extinct. As such, it is unclear the direction that Europe will take, as reactionary forces such as Marine Le Pen’s party in France begin to gain steam. At a minimum, then, greater instability is likely in the short- to medium-term.

Bond Yields are Stubbornly High

‘Buy the Dip’ Investing Mantra Lives On – in the Bond Market at Least

Jack Pitcher, The Wall Street Journal

Decoding the (Almost) 5% 10-Year Treasury Yield

Sam Goldfarb, The Wall Street Journal

Investors have brought a total of $21 billion to a 20+ Year Treasury Bond ETF, despite the fund losing over half its value from its peak in 2020. TLT, the fund’s ticker, invests in long-dated US Treasury bonds and yields around 5%, similar to the 30-year bond. It has been the recipient of more money than any other fixed-income, exchange-traded fund this year. Some investors in TLT, betting that interest rates may soon begin to fall, plan on gaining from the price appreciation on long-dated bonds that benefit from falling rates, as those bonds are particularly sensitive to such moves. Many of the investors are also seeking exposure to fixed-income to receive higher yields, which have skyrocketed this year to above 5% from a low of 3.5% in April. So far, investors ‘buying the dip’ in TLT have yet to see returns – but if yields lower by half a percentage point, investors would see a 13% return over the next 12 months. A full percentage point lower would lead to a 23% return.

Attention should also be directed to an important economic benchmark: the 10-year Treasury note. The note’s yield, which roughly correlates with investors’ expectations about average interest rates over the bond’s life, reached 5% last week, the highest in 16 years. Yields on T-bills influence borrowing costs in the economy, and their rise (which has gone on for almost two-years now) has analysts nervous that the economy could fall into recession. One signal is the inverted yield curve, a term describing an anomaly where longer-term Treasury yields are below short-term ones. This was the case for much of the last two years, which meant that investors believed that interest rates would fall in the future due to a recession. However, data released this summer began to show that economic growth was accelerating while inflation was slowing down. Given this information, many investors no longer see an imminent slashing of the interest rate by the Federal Reserve.