International terrorism is a complex geopolitical issue that threatens to undermine the security of cities, countries and markets worldwide. Unprovoked attacks upon civilians and infrastructure create a sense of fear and apprehension towards the future of civilisation itself. In the past two decades, these include acts of terror committed in New York City (2001), Madrid (2004), London (2005), Mumbai (2008), Paris (2015) and Brussels (2016).
As a general rule, any development that casts doubt upon the viability of the economic status-quo has a tendency to send shock waves through both domestic and foreign markets. An act of terror serves to create uncertainty within the marketplace, which can lead to investor apprehension and many unforeseen financial consequences. Depending on the degree and nature of the attack, various equities, currency and commodities markets around the globe may experience unexpected volatilities and turbulence.
Market Fallout: Acts of Terror In 2017
In the years 2016 and '17, unexpected terror attacks became more prevalent than in previous years. A universal definition of what exactly constitutes an "act of terror" is a hotly debated topic. However, unofficial studies estimate that for the first nine months of 2017 there were 918 separate terror attacks resulting in 5,239 fatalities worldwide.
The impact that an act of terror has on the marketplace varies depending on the type of attack, locale and time in which it was committed. Some acts of terror cause only a regional disturbance spiking volatility in domestic markets, while others send shockwaves through the entire global financial system. No matter the size and scope of the act, it brings uncertainty to the marketplace and ensures enhanced volatility facing a wide variety of asset classes.
London has experienced several such incidents over the course of 2017. On 22 March, a vehicle attack on Westminster Bridge and the subsequent altercation ended with five fatalities and more than 50 people injured. In the midst of a precautionary lockdown of Parliament and Westminster, the GBP experienced panic selling and an immediate 50 pip decline against the USD before recovering at session close.
On 5 June, London was once again a target when assailants committed a vehicle attack on London Bridge. In a coordinated onslaught, many people were victims of aggression in the Borough Market area at the same time. Again, this attack had immediate repercussions on the GBP, eliciting a 0.3% sell off against the USD. In much the same fashion as in March, the pound quickly recovered as the situation became under the control of authorities.
The economic fallout from the London attacks was largely regional and fleeting as the GBP saw the greatest shock during their aftermath. However, the mid-August vehicle attack on a popular tourist area in Barcelona, Spain had an international impact.
In the aftermath of the Barcelona incident, global equities were hit hard. U.S. markets reacted swiftly and decisively to the breaking news out of Spain:
- The DJIA fell 275 points, a drop of 1.2%
- The S&P 500 sold off 1.5%
- The NASDAQ declined nearly 2%
European equities indices did not escape the tumult:
- The FTSE 100 fell 0.9%
- Bolsa de Madrid lost 0.5%
- Markets in Frankfurt and Paris also retreated on the news
Markets react to each new terrorist threat or attack in seemingly random ways. Traders and investors rapidly evaluate the circumstances surrounding the event and craft strategies on-the- fly to either preserve or create wealth. These swift actions increase market participation and exponentially enhance pricing volatility.
The Impact Of Terrorism Upon The Marketplace
The unpredictability of a terror attack is the mechanism by which confusion is created within a specific financial market or group of markets. While it is largely impossible to account for an unknown future event ahead of time, it may be even more challenging to manage capital exposure and risk within a market during a period of unforeseen chaos.
Markets are dynamic systems that often behave erratically to unexpected news, and an act of terror provides such stimulus. As a result, an affected marketplace may experience several direct and indirect consequences:
- Short-term volatility: Sudden pricing fluctuations may occur as a result of a spike in market participation created by uncertainty related to the terror attack. For instance, during the train bombings in Madrid, Spain on 11 March 2004, the Dow Jones EURO STOXX index fell 3% on heavy intraday selling.
- Market stabilisation: In the trading sessions following the event, traders and investors typically become interested in capitalising upon opportunity or limiting risk. In the case of the Madrid bombings, the value of the Dow Jones EURO STOXX index recovered almost completely within the month.
- Long-term impact: As a result of the market volatilities observed in the wake of numerous terror attacks, increased regulations and safeguards have been put in place to mitigate risk created by terrorist activities. For instance, the ability to suspend trade through the use of a "circuit breaker" has been enacted in many markets around the world to limit exposure attributed to terror attacks.
Each act of terror produces a unique degree of fear and financial uncertainty. Some attacks impact only specific or regional markets, while others send shockwaves throughout the entire international financial system. Ultimately, how much certain securities products and marketplaces are impacted is dependent upon the sentiment of market participants.
The Global Impact Of Terrorism: The Spillover Effect
Trading and investing within the financial markets is an international endeavour, with increasing levels of globalisation leading to an advancing interrelationship between the markets themselves. Often, participants engage any number of markets simultaneously, promoting open trade and investiture throughout the world.
The economic theory of "spillover" addresses the relevance and influence of an event both locally and abroad. The theory of spillover states that a secondary effect following a primary reaction may be far removed from the initial event that caused the primary reaction. When applied to international financial markets during periods of terrorist activity, the spillover effect accounts for unusual market behaviour observed far from the initial event or act of terrorism.
Academic studies have attempted to illustrate the presence of economic spillover during periods surrounding terror attacks. One commonly referenced study in this area was research made available in 2004 by A.H. Chen and T.F. Siems. The study quantifies the degree of interrelation present in various global markets during the terrorist attack in the United States on 11 September 2001.
In order to accomplish their objective, Chen and Siems developed an abnormal return (AR) value for 33 of the world's largest capital markets, using the most significant equities index (comparable to the NYSE in the U.S.) in each locale as the reference point. The results showed that nearly 94% of the sample exhibited a negative AR.
In addition, the top ten largest international capital markets experienced substantial negative ARs for the trading session of (or first active session upon re-open) 11, 12, and 17 September 2001:
- NYSE: -4.55%
- London: -5.29%
- Tokyo: -6.20%
- Frankfurt: -7.61%
- Paris: -7.07%
- Toronto: -4.05%
- Amsterdam: -6.94%
- Switzerland: -7.03%
- Italy: -7.71%
- Hong Kong: -8.45%
Chen and Siems' examination of the global market fallout after the September 11, 2001 attacks serve as a good illustration of the spillover effect as it pertains to global financial markets. According to the data metrics, an event the size and scope of the September 11th attack has a profoundly negative impact upon both domestic and international markets. The attack occurred in the U.S., but the shockwave and economic fallout was felt throughout the world.
An academic paper released in 2013 by S. Kumar and X. Liu examined spillover from the perspective of an attacked country's trading partners. The results of the study showed that when a larger country (in terms of GDP) is targeted, its smaller trading partners suffer in the immediate and intermediate term. The likelihood of a substantial decline in the equities markets of the smaller trade partner is observed to be 5.7 times greater than in other countries. The decline is substantial, averaging -2.5% applied to the domestic stock indices.
The sudden uncertainty created by terrorist attacks brings into question the future economic viability of global leaders and developing nations alike. Due to the connectivity between global marketplaces, the impact of a large scale terror attack is likely to be widespread and substantial.
While intraday and intermediate volatilities typically spike amid a major terror attack, financial markets prove resilient. This point is emphasized by the work of Chen and Siems through their synopsis of the recovery of global equities markets in the period immediately following the September 11, 2001 attacks on the United States.
Listed below is the number of days it took each of the ten largest international capital markets to return to valuation levels seen immediately before September 11, 2001:
- NYSE: 37
- London: 22
- Tokyo: 14
- Frankfurt: 23
- Paris: 31
- Toronto: 44
- Amsterdam: 42
- Switzerland: 30
- Italy: 31
- Hong Kong: 20
While many factors must be taken into account when examining the time it took for each global market to recover, the important point is that each managed to do so. The immediate sell-off and subsequent loss in value of the equities indices was only temporary. Recovery may not have been universal on a company-by company basis, but in the aggregate, confidence and value from market participants did return relatively short order.
Responding To Terrorism: Financial Safe-Havens
The overriding theme of terrorism is the creation of fear. As mentioned, fear in the financial arena typically leads to short-term volatility, which is likely to spread from market to market. In an attempt to combat the risk created by turbulent markets produced by a terror attack, traders and investors often rapidly transfer capital into "safe-haven" assets.
A safe-haven asset is one that is anticipated to retain or gain value in the event that other avenues of investment have depreciated. As uncertainty raises its head, market participants commonly take an aggressive approach to either exiting the market altogether or moving capital into these types of instruments.
Financial safe-havens may exist as commodities, currencies or debt instruments. Listed below are a few of the most traditional safe-haven assets:
- Gold: In troubled times, gold has been one of the go-to modes of wealth preservation. It provides a hedge against the devaluation of fiat currency in addition to holding a physical value. The March 22, 2016 Brussels terrorist attack provided an example of traders and investors rushing into gold during uncertain times. For the trading session of March 22, 2016, gold prices rallied .9% to US$1,255.60 per ounce amid an intraday selloff in European equities.
- Government bonds: In times of peril, guaranteed debt from reputable governments can be in high demand. The U.S. 10 year Treasury Note is one of the world's prominent debt instruments. During the immediate aftermath of the December 19, 2016 terrorist attack in Germany, traders and investors moved capital into U.S. 10 year notes as a means of protecting their wealth.
- Currencies: The national currency of several countries around the world serve as traditional safe-haven assets. The Japanese yen (JPY), Swiss franc (CHF), US dollar (USD) and British pound (GBP) have served as safe-haven currencies for many years. Currency trading in the aftermath of the November 13, 2015 Paris terror attacks showed favour to the JPY and CHF in place of the domestic euro (EUR). In the wake of the Paris attacks, the EUR fell to six-month lows against the JPY, while the CHF posted a .3% gain.
Although the gains posted by commodities such as gold, bonds and assorted currencies during the time surrounding a terror attack may be fleeting, it is important to recognise the spike in market participation and volatility during such periods. As a terror attack unfolds, it is common for traders and investors located around the world to shift their focus towards "safer" asset classes. This may prompt strength in certain financial instruments and weakness in others.
Sept 2019 Attack: Impact Upon Commodity Pricing
The September 2019 attack on Aramco oil production facilities in Saudi Arabia sent a shockwave through the global oil and gold markets. While extreme volatility in oil pricing was to be expected, the action in gold also picked up as investor demand for safe-haven assets increased.
Drone Strikes Hit Aramco
In the early morning hours of 14 September 2019, a coordinated drone strike targeted two separate Aramco oil facilities located in Saudi Arabia. As the world's largest energy company, Aramco generates 12.5 million barrels of oil per day and plays a primary role in the global supply chain of crude oil.
The attacks disrupted operations, reducing output by an estimated 5.7 million barrels per day, which represents nearly 50% of Aramco's capacity and 5% of the global supply. On the humanitarian front, the damage was minimal. No fatalities or injuries were reported by Saudi Arabia or Aramco.
The attacks occurred during a weekend, coincidentally while energy futures markets were closed. Ahead of the pending market re-open, industry insiders predicted major spikes in the pricing of both North Sea Brent (Brent) and West Texas Intermediate (WTI) crude oil futures. Panic-like trading conditions were expected, with a multitude of analysts calling for instant US$5 rallies in Brent and WTI due to concerns over a supply shortage.
Many of the extreme predictions proved accurate, as heavy volatility and bidding hit the markets immediately following the electronic opening bell. For the ensuing Monday, 16 September 2019 session, bullish sentiment dominated the trade of global oil:
- November WTI crude oil futures rallied by a whopping US$7.87 per barrel, totalling a 14.36% single-session gain.
- November Brent crude oil futures posted gains of $8.80 per barrel, a staggering one-day rally of 14.61%.
As a general rule, the financial markets do not like uncertainty. The Aramco drone strikes generated widespread concerns over reduced oil supplies and the future of global economic growth. Subsequently, as market participants attempted to limit systemic risk exposure stemming from the attack, December gold futures saw extensive bids for the week of 16-20 September 2019. Gains of US$15.60 per ounce were realised over the course of the five-sesion trading week, an uptick of 1.04%.
What Goes Up, Must Come Down
In the immediate aftermath of the Aramco attacks, the Yemen-based Houthi rebels issued public statements taking credit for the incident. Citing the deployment of 10 drones, spokesman Yahya Sarea claimed Houthi responsibility for the strikes and pledged future actions. In a swift rebuttal, U.S. Secretary Of State Mike Pompeo immediately went on record via Twitter, attributing the attacks to Iranian aggression:
"Tehran is behind nearly 100 attacks on Saudi Arabia while Rouhani and Zarif pretend to engage in diplomacy. Amid all the calls for de-escalation, Iran has now launched an unprecedented attack on the world's energy supply. There is no evidence the attacks came from Yemen."
In a series of 15th September tweets, Pompeo's remarks were echoed by U.S. President Donald Trump. The president also opened the U.S. Strategic Oil Reserves to stabilise the global energy markets:
"Based on the attack on Saudi Arabia, which may have an impact on oil prices, I have authorized the release of oil from the Strategic Petroleum Reserve, if needed, in a to-be-determined amount….
"….sufficient to keep the markets well-supplied. I have also informed all appropriate agencies to expedite approvals of the oil pipelines currently in the permitting process in Texas and various other States."
While the dialogue from the Trump administration did not stave off Monday's spike in WTI and Brent crude oil pricing, it did bring a degree of reassurance to the marketplace. Pledges to shore up shrinking oil supplies with the U.S. reserves, and to physically defend Saudi Arabia if needed, proved to limit the ferocious rally in the global oil markets. As a result, the Tuesday, 17 September 2019 trading session produced a staunch challenge to the post-attack rally:
- November WTI crude oil futures plunged US$3.57 per barrel, closing down 5.7% on the session.
- November Brent crude oil futures sold off by US$4.47 per barrel, closing the session at a loss of 6.48%.
Although acts of terror work to destabilise the international financial system, each does so in a unique fashion. As observed in the days following the Aramco drone strikes, commodities such as crude oil and gold may experience extreme volatility as market participants evaluate the market fallout.
Financial markets are often cited as a barometer of national or regional health. A market's sensitivity to uncertainty, and ability to recover after a shock, speak to the flexibility of the global financial structure.
Terrorism creates uncertainty, and as a general rule, markets do not like uncertainty. Volatilities ensue, with participants choosing to transfer assets to safe-havens or exit the market altogether. Initial economic fallout from a terrorist attack may be widespread and severe, but over time markets do begin to exhibit more rational behaviour and work towards recovery.
The globalisation of economics and the nature of business have created an atmosphere of connectivity between the nations and marketplaces of the world. Advances in technology have made the near-instantaneous spread of news to the far corners of globe possible. The very instant a happening with the significance of a terrorist attack occurs, the financial world knows about it and conducts business accordingly.
Unfortunately, the risk and influence of terrorism upon the international capital markets is very real. While attacks are unpredictable in nature, individuals must respect their impact while having a definitive plan of action to deal with adversity should the situation arise.
This article was last updated on 9th October 2019.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…