The appointment of Mohamed Bin Salman as Crown Prince of Saudi Arabia is likely to result in more geopolitical tension in the Middle East.
Bin Salman was the leader of the Saudi military action in Yemen and seems to have been a key mover in the recent Gulf Cooperation Council (GCC) actions against Qatar. We see the change in succession as largely being about the ongoing geopolitical rivalry between Saudi Arabia and Iran. The new Saudi regime seems anxious to exploit the shift in U.S. policy away from the approach of the previous administration, which the Saudis saw as too friendly to Iran. The Saudis were certainly successful in getting Trump to side with them regarding Qatar, despite the objections of the State Department and its beleaguered head, Secretary of State Rex Tillerson, and despite the presence of a major U.S. military facility in Qatar.
The Middle East’s evolving significance
At the same time, it seems that markets have become inured to Mid-East tension, despite an increase in terrorism and instability. The recent evidence is that even quite large terrorist incidents have only passing effects on markets. Political instability in the region has important political effects, especially via Europe’s migrant crisis, but similarly has had little lasting impact on markets.
The oil market has also changed
The Mid-East region is traditionally important because of its role in energy production. The Organization of Petroleum Exporting Companies (OPEC) has recently managed to regain just a little credibility, despite the political differences among its key members. However, it’s also true that as oil becomes more and more like a normal commodity, OPEC matters less and less. The United States itself has become a key marginal supplier of oil. So the prospect of increased political tension in the Persian Gulf seems likely to matter less for oil now than it might have some years ago. On a fundamental level, our fair value model has pushed up its estimate of oil prices, and we see some supply factors that could also contribute to oil price increases.
Reason for discomfort
We would be uncomfortable dismissing the prospect of further political tension in the Middle-East as essentially irrelevant to our economic and market outlook. With key questions being posed about the U.S. role around the world, and genuine uncertainty about the answers to those questions, we are nervous about the possible implications of the shift in Saudi leadership for asset markets.
While the fundamentals of the global economy remain positive, an uptick in real interest rates offers a taste of the potential for policy error.