A Weapon of War
The Hammer’s a weapon of war Just ask those who fought against Thor At midnight on Friday Iran learned the hard way That Trump wields one too when called for The interesting thing early on Is this clearly ain’t a black swan While oil did rise Which was no surprise Most risk gave an aggregate yawn
Obviously, the big news this weekend was the extraordinary attack and destruction of Iran’s three key nuclear enrichment and engineering sites. While this poet has opinions, since I am just like the rest of you, limited to the peanut gallery and with no voice in the matter, they are not relevant for this discussion. However, what is relevant is the early movement in markets once they reopened Sunday night in NY. While it is no surprise that oil’s price rose as you can see below, the early 2.2% gain is pretty lackluster for the alleged (by some) beginning of WWIII.
Source: tradingeconomics.com
As to the rest of the markets early price action, it’s largely what you would have expected directionally, although unimpressive overall with equity indices modestly lower, about -0.35%, the dollar modestly higher, about 0.2%, and bonds little changed. Gold, too, is little changed. It appears that, at least initially, the market was anticipating something like this as you can see that even after the oil price spike, it didn’t reach the levels seen on Friday.
With two days to think it all through Most traders appear to eschew The idea that war Is what is in store Instead, buy more stocks is their view
So, as we wake up Monday morning, despite all the weekend news and the fear mongering thus far, and even though Israel and Iran continue to trade missile fire, the early consensus is that we have seen the worst already. Iran’s parliament voted to block the Strait of Hormuz, but they have no power to drive actions, that resides with the Supreme Council and as of yet, they have not acted. In fact, they are in a tricky position for several reasons. First, China is their largest oil customer by far and 20% or more of their oil transits the Strait which means China’s deliveries would slow dramatically and China is one of their only supporters. Second, the US navy has significant assets in the region and appears quite ready for that move, likely being able to reopen the Strait quickly. And third, if they follow through and their objective fails (remember, their objective in this would be to spike the oil price and hurt Western economies accordingly) then they will prove conclusively that they are irrelevant militarily. That is likely not what the regime there wants to demonstrate.
But the market is pretty smart about these things as the collective wisdom and thoughts of traders and investors is an excellent proxy for issues of this nature. Therefore, we cannot be surprised that after that initial spike in oil prices, they have retreated to Friday’s pre-attack levels as investors await more information.
Source: tradingeconomics.com
It is also worthwhile to recognize that speculative trader positions in oil are net long just under 200K contracts, so there is no short-covering spree that is likely to arrive and drive prices higher.
Source: en.macromicro.me
The point is that if oil is basically unconcerned with the potential issues in Iran, then other markets will completely ignore the situation. And that is pretty much exactly what we are seeing this morning. In Asia, equity markets were mixed with modest overall movement. The Nikkei (-0.15%) and Australia (-0.35%) slid while Hong Kong (+0.7%) and China (+0.3%) rallied showing no trends whatsoever. The rest of the region did have more laggards than gainers, but other than smaller markets like Indonesia and Taiwan, both falling -1.5% or more, movement was muted. In Europe, modest losses are the thing with the DAX (-0.4%), CAC (-0.4%) and IBEX (-0.2%) slipping a bit while the FTSE 100 is unchanged on the morning, but there is certainly no panic. As to US futures, while they opened lower last night, as I type at 6:30 this morning, they are back to flat on the session.
In the bond market, yields have basically edged higher by 2bps across the US, Europe and Japan, either demonstrating that government bonds are no longer a safe haven, or that no haven is necessary because fears of escalation are minimal. Despite all the negative talk about bonds, I would still opt for the latter explanation.
In the commodity markets, we’ve already discussed oil at length. In the metals markets, gold is essentially unchanged this morning although we are seeing a mild divergence between silver (+0.6%) and copper (-0.7%), implying to me that there is no underlying risk trend here.
Finally, the dollar is the one thing that is flexing its muscles from a risk perspective as it is pretty sharply higher across the board. In the G10, NZD (-1.4%) is the laggard followed closely by the yen (-1.25%), which given the weekend’s events is pretty surprising to most folks. Perhaps yen is not as haven-like as previously thought. But AUD (-1.1%) is sliding and the euro and pound are both lower by -0.5%. In the EMG bloc, the dollar is firmer everywhere, but the moves, other than KRW (-1.2%) are less than might have been expected. HUF (-0.9%) is the next worst performer with PLN (-0.75%) and CZK (-0.75%) all showing their high beta to the euro. In Asia, CNY (-0.15%) remains dull and INR (-0.2%) is also lackluster. LATAM currencies are showing little movement as well, with MXN (-0.4%) the laggard of the bunch.
Looking at data this week shows the following:
As well as all this, with most folks looking forward to Friday’s PCE data, we hear from Chairman Powell as he testifies to the Senate on Tuesday and the House on Wednesday. In addition, there are 13 more Fed speeches from 10 different speakers. Too, Madame Lagarde regales us three different times. A cynic might think that central bankers are concerned their comments are losing their importance!
One never knows what is truly happening on the ground in Iran as all news organizations and governments are trying to tell their own story. However, I do not believe that this is going to escalate into a greater problem going forward, but rather that there is every chance that tensions reduce over time. I do not believe Iran will even attempt to block the Strait of Hormuz and if this is the worst that the Middle East can produce in the way of war, look for oil prices to slide back toward $65-$70. As to the dollar, it feels a bit overdone here, so a modest retracement seems viable as well.
Good luck
Adf
It’s almost a sense of calm, meaning, where almost everyone knew Iran getting a nuclear weapon was really bad. Yet as a whole the country is tired of endless wars and losing them because they weren’t worth starting. But a sigh of relief came when (if ultimately true) destroying their nuclear sites was a necessary risk vs the risk of not doing it. The quietness of the markets and largely ignored actions from other Middle Eastern countries leads me to believe a large majority of the world knew this was somewhat an evil necessity for immediate and short/middle term global security. Just my opinion. Great take Andy, I really enjoyed it.
Hey Andy, well written. I completely agree with your view on Iran. The closure of the Strait of Hormuz feels more like a scare tactic than a real risk. In addition to what you mentioned, I’d add that Saudi Arabia and UAE already developed alternative infrastructures. For example, Saudi Aramco is already shifting seaborne crude flows away from the Strait of Hormuz by using its East-West pipeline to transport oil overland to ports on the Red Sea.
Similarly, the UAE’s upgrades have allowed them to boost exports of their lighter crude grades and increase use of the pipeline to the Fujairah export terminal. This increased daily use of the pipeline limits the extra capacity available to reroute additional volumes around the Strait of Hormuz. So, the potential disruptions could be offset by these pipelines.