Last week’s horrific terrorist attacks in Paris were a reminder that, unfortunately, the ongoing fight with global terrorism is still with us, and my thoughts are with those affected by the tragedy.
In a new paper, “After the Paris Tragedy,” the BlackRock Investment Institute recently shared some insights on how this significant escalation in the intensity of the terrorist threat could impact the economy and markets going forward. Here are three of the key points.
Episodes of terror tend to accentuate existing economic and market trends, rather than constitute turning points. The market impact of past terror episodes, including the 2005 London bombings and 2004 train bombing in Spain, was generally ephemeral, according to a BlackRock analysis of data accessible via Bloomberg. In other words, the attacks created headlines, become market talking points and then disappeared. If anything, they heightened the trajectory of the economy and markets. For instance, the September 11 attacks magnified the 2001 U.S. tech bubble recession, but didn’t cause it.
Similarly, in the near term, the tragedy in Paris is likely to bolster economic trends already underway in Europe. The fallout from these attacks will probably put some pressure on the French economy as well as the euro. A likely (but reversible) dent in European consumer confidence should cement plans by the European Central Bank (ECB) for more easing measures in December. Meanwhile, France will likely further loosen the austerity reins to boost defense spending, with other European Union (E.U.) members following suit.
The longer-term impact of Paris could be different. The cause of the Paris attacks is rooted in a systematic breakdown of state control in the Middle East. The region is dogged by the aftereffects of the Arab Spring, sectarian conflicts and proxy wars between Sunni Saudi Arabia and Shiite Iran, and this cycle may just be getting started, as seen in recent attacks on civilians and the bombing of a Russian airliner.
With the Islamic State (ISIS) and its affiliates set on internationalizing their reach, the terrorist threat against the West is likely the highest it has been since 2001. If the Paris tragedy marks an evolution toward an extended, global conflict, the market impact could be much greater than past terror attacks stemming from regional conflicts.
In addition, the Paris tragedy will complicate the path toward a political solution to the European refugee crisis, and the outcome is still unclear. It could lead to closed borders and harden the case in the U.K. for leaving the E.U., or alternatively, we could see more cooperation and integration among E.U. members.
Geopolitics could start having a greater influence on markets going forward. Markets will have to contend with many political uncertainties in 2016. These include possible setbacks to the European project in the face of the refugee crisis and risk of more terror attacks; rising instability in the Middle East likely to be aggravated by the impact of low oil prices; a Russia and China increasingly assertive abroad while grappling with economic slowdowns at home; and a U.S. presidential election with a wide-open field of candidates and outcomes.
These risks are playing out against a backdrop of asset prices propped up by years of plentiful liquidity. Liquidity conditions may be less benign in 2016. The Federal Reserve (Fed) is set to raise interest rates for the first time in nearly a decade, and the events in Paris aren’t likely to alter this. Elsewhere, emerging market central banks and sovereign wealth funds have been selling reserves and risk assets to defend currencies and or plug budget holes.
This means markets are likely to pay more attention to geopolitics going forward, and it calls for cautious navigating in 2016. For more on the likely ramifications of the Paris terror attacks, read the full paper from the BlackRock Investment Institute, “After the Paris Tragedy.”
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.
