Key Points:
• The Kingdom of Saudi Arabia (KSA) is being blamed for the disappearance and possible death of U.S. resident and journalist, Jamal Khashoggi
• The Trump administration is considering sanctions against the kingdom in response
• Saudi Arabia has vowed retaliation if sanctions are imposed
• The U.S. relationship with Saudi Arabia has long been complicated and continues to be. If sanctions are imposed, some economic and military ties will remain unchanged even if diplomatic stridency and public outrage increase
Background:
• On October 2, Jamal Khashoggi, a Saudi citizen and U.S. resident, was last seen entering the Saudi consulate in Istanbul
• Khashoggi, previously enjoyed a close relationship with the Saudi Royal Family, serving as an adviser to the director of Saudi Arabia’s Intelligence Agency
• Khashoggi became critical of the oppressive regime in the kingdom, becoming a vocal opponent of the Religious Police and the ultra-conservative interpretation of Islam imposed by the government
• Most recently, Khashoggi published critiques of Mohammed bin Salman (MBS) – a supposed advocate for reform and liberalism
• Khashoggi has been critical over Saudi Arabia’s diplomatic break with Qatar and the war in Yemen, as well as Saudi Arabia’s policy toward Iran
• In June 2017, Khashoggi, fearing arrest, left Saudi Arabia, resettling in the U.S.
“I have left my home, my family and my job, and I am raising my voice, to do otherwise would betray those who languish in prison. I can speak when so many cannot. I want you to know that Saudi Arabia has not always been as it is now. We Saudis deserve better.” Jamal Khashoggi
What Has Happened:
International attention and pressure have mounted on Saudi Arabia. President Trump has promised a serious punishment if it is determined Saudi Arabia killed Jamal Khashoggi. This weekend KSA responded that they would retaliate if the U.S. imposed sanctions. Saudi Arabia has argued that any sanctions on the kingdom would drive up oil prices, ultimately hurting the U.S. and its allies. U.S. allies, Britain, France, and Germany called for a credible investigation by Saudi and Turkish authorities.
Why it Matters:
“I suspect that MBS has made a grave error if the murder accusations are true. I believe if nothing comes out from the Kingdom, other than defensive threats to those questioning why there is no response, then relations will continue to decline. This can have a significant impact on US defense industries (given the extensive Saudi contracts) and could likely cause a reactive rise in oil prices just because of the international attention – even without Saudi retaliation to any US actions. Fear will drive the oil market without clarity of intentions. I don’t think the President wants to take economic actions and it is likely sanctions would have to be creative if imposed to allow defense contracts to continue. Saudi threats to lean toward Russian or Chinese military equipment are real and when we have not sold them defense articles in the past, they have gone elsewhere. Congressional and press pressures ahead of elections will drive the administration to take some action as the U.S. public is unlikely to consider the complexities of actions and counter reactions, they rightfully expect our government not to tolerate an attack on a U.S. resident and member of the press.”
Lieutenant General Frank Kearney, Academy Securities’ Advisory Board Member.
Given General Kearney’s assessment, I think we can see a few short-term impacts. The implications of these actions, even if overblown, will resonate with a market already nervous heading into midterm elections.
More weakness in treasuries as KSA will need to fund their current expenses and selling treasuries (which they owned $166 billion as of the last TIC report – up from $90 billion in October 2016. Often, we would expect risky situations to cause a flight to quality and benefit treasuries, but when KSA has had to sell assets before to support their generous public payouts – treasuries (and stocks have suffered). We might expect to see a divergence between Brent crude and WTI. KSA is already selling to China in Chinese currency and this could accelerate that move. My view on the long-term potential of LNG may still hold, but near term, it could be under pressure if KSA further embraces China. I would avoid dollar denominated debt of KSA and its major banks at this point. As we saw in Turkey – the potential for the ‘situation’ and markets to get out of control is high.
Peter Tchir, Academy Securities’ Head of Macro Strategy
Original Post 10/14/2018