The Cable

The End of Teflon Markets?

Markets shrugged off increasing geopolitical tensions for months, but lately investors seem more sensitive to flare-ups in Ukraine and the Middle East.

U.S. stock markets sailed through Russia's March annexation of Ukraine's Crimean peninsula and months of tit-for-tat sanctions between Moscow and the West. The Dow Jones industrial average gained more than 300 points that month. When Islamist militants started capturing key Iraqi cities in June, threatening the integrity of Iraq, markets continued to climb steadily. By the end of June, the Dow had gained 500 points since the beginning of the year.

Now, over the past few weeks, markets suddenly seem to be jumpy. Since the middle of July, when Israel invaded Gaza, adding another hot spot to potential investor concerns, the Dow has dropped about 500 points, trimming most of its gains from this year. After an uptick on Monday, Aug. 11, U.S. stock markets wavered Tuesday morning on news that dashed hopes of greater political stability in Ukraine and Iraq. Are the markets newly sensitive to a whole host of international crises?

The standoff between Russia and the West over Ukraine has perhaps the biggest potential to damage the global economy, and a new potential flash point took shape this week. Although Moscow, Kiev, and the Red Cross agreed on Monday to coordinate aid for eastern Ukraine, by Tuesday the arrangement seemed to further rattle, rather than calm, nervous investors. Trucks supposedly carrying Russian humanitarian aid rumbled toward the border with Ukraine Tuesday morning, even though Kiev said it will only accept supplies crossing the border in Red Cross trucks.

Developments in Iraq also gave investors reason for pause. Prime Minister Nouri al-Maliki refuses to cede his position to a newly appointed successor. His obstinacy threatens a government transition that Barack Obama's administration hails as a step forward for the country that is trying to fight a powerful militant insurgency.

Douglas Rediker, a visiting fellow at the Peterson Institute for International Economics and a former IMF executive board member, said markets have been "remarkably sanguine over broad geopolitical risk" until recently. Oil markets are being remarkably impervious to bad news out of the Middle East. The International Energy Agency said Tuesday in its monthly report that increases in production from North America mean there is plenty of oil to go around, despite conflicts in oil-producing countries such as Iraq and Libya.

But it's too early to say whether U.S. stock markets have developed a new sensitivity to bad international news or will continue their ho-hum progress after this latest dip.

Powerful counterforces are pushing markets up, most importantly the easy-money policies of the U.S. Federal Reserve. After holding U.S. interest rates low for so long, driving down returns on safe investments such as Treasury bonds, investors are looking far and wide for assets that will deliver returns, no matter how risky.

"People have become probably a little bit complacent about the risks that are out there, but they don't have many other options for their portfolio," said Robert Johnson, director of economic analysis at investment research firm Morningstar.

Without a lot of safe options, investors become less sensitive to risks of all sorts, whether financial or political.

Johnson said the market is much more sensitive to announcements from the Fed about when it will start raising interest rates than the various crises around the globe. He said the markets similarly were unfazed by the Arab Spring and the upheaval in Libya.

"What's happening is we've had so many of these events happen over the past three of four years that traders are getting a little numb to them," Johnson said.

If the Fed were to change policy, geopolitical risks could become more of a concern for investors, but until then, it's unclear whether bad headlines are enough to dampen investors' enthusiasm over the long term.

"On one side you've got central bankers' expansionary monetary policy creating exceptionally low volatility, and on the other hand you've got a series of geopolitical hot spots that are escalating as a trend, and the question is, which one is going to win out?" Rediker said.

Photo by John Moore/Getty Images

National Security

Washington Wants Maliki Out. What If He Refuses to Go?

The Obama administration is welcoming the nomination of a new Iraqi prime minister while doing all it can to ease the current one out the door. With Nouri al-Maliki showing no signs of leaving, however, the White House will soon need to decide how hard it's willing to push.

On a day of high drama and deep uncertainty for both Baghdad and Washington, Iraqi President Fouad Massoum tapped Haider al-Abadi, a prominent Shiite politician who serves as the deputy speaker of the Iraqi parliament, as the country's prime minister-designate. President Barack Obama and Vice President Joe Biden called Abadi to congratulate him and urge him to quickly form a new government of national unity. Obama said the United States was prepared to ramp up its military support for the battered Iraqi military if Abadi struck power-sharing deals with the country's Sunni and Kurdish minorities.

"The only lasting solution is for Iraqis to come together and form an inclusive government, one that represents the legitimate interests of all Iraqis and one that can unify the country's fight against ISIL," Obama said Monday, using an acronym for the militant group that has conquered broad swaths of Iraq and Syria. "Today Iraq took a promising step forward."

Obama didn't mention Maliki's name a single time during his brief public remarks, a clear sign of how desperately the White House wants to turn the page on the hard-line Shiite politician's tenure as Iraq's leader. U.S. officials accuse Maliki of pursuing nakedly sectarian policies that have persuaded many Sunnis to cast their lot with the militants who call themselves the Islamic State.

Maliki, however, has rejected calls to step aside and has taken steps this week that raise the dark prospect of a coup. On Sunday night, Maliki accused Massoum of violating the Iraqi constitution by trying to replace him. A short time later, tanks and soldiers from Iraqi units under Maliki's direct command surrounded Baghdad's Green Zone and set up checkpoints across Baghdad, raising fears that Maliki would use force to either intimidate Iraqi lawmakers into giving him a third term in power or dissolve Iraq's parliament altogether.

The moves drew a stern rebuke from Secretary of State John Kerry, who warned Maliki against using Iraq's military for political purposes and said that any use of force would lead Washington and its allies to cut off their aid to Iraq.

"One thing all Iraqis need to know, that there will be little international support of any kind whatsoever for anything that deviates from the legitimate constitutional process that is in place and being worked on now," he said.

Still, it's far from clear that the United States has enough leverage to force Maliki to give up power if the Iraqi leader refuses to do so peacefully.

"I don't know if there's anyone in the United States who he listens to anymore," said Steven Cook, a senior fellow at the Council on Foreign Relations, referring to the embattled prime minister. "Everyone admits that the Iranians have more leverage than the United States."

While Washington could threaten to call back the roughly 800 U.S. military advisers in the country and withhold future weapons sales to Iraq, such moves would make it even harder for Baghdad to retake the territory it has lost to militants from the Islamic State or prevent them from advancing further north. As long as the Islamic State remains a threat, Cook said Washington will be reluctant to withdraw military support from Iraq despite its anger at Maliki.

The White House is "not ready just yet to punish ourselves by punishing the Iraqis," he said.

Douglas Ollivant, who formerly served as the top Iraq policy official on the National Security Council, said there was "very little" the United States could do to push Maliki out of power, but he said he didn't think the Iraqi leader would resort to violence to stay in office.

"I really think it's all done but the shouting," Ollivant said. "He's going to talk tough and play out his last legal card, but he doesn't want to be an international pariah. If we pull away, his only friends would be Iran and Syria, and even Maliki doesn't want that."

If Maliki does eventually step aside, the White House will face a new set of tough questions about the way forward in Iraq. Obama has consistently said the United States would be willing to ramp up its military support for Baghdad once Maliki is out of power and a new national unity government has taken over, but the president has ruled out the use of American combat forces and been deliberately vague about the type of air campaign he would consider undertaking. Once Abadi takes charge, however, Obama will have to choose just how far he will actually be willing to go.

Sabah Arar/AFP/Getty