Financial markets reacted moderately to the US and Israeli bombings of Iran, as part of the geopolitical risk was already priced in, but in the short term risk aversion will dominate, with dollar appreciation and significant increases in oil prices, according to an analysis by a global financial services firm.
”The biggest risk for markets remains a possible closure of the Strait of Hormuz, a scenario that could push crude oil prices towards $100 per barrel,” analysts said. Meanwhile, the Commander of the Iranian Revolutionary Guards announced on Monday that the Strait of Hormuz is closed to maritime traffic and that Iran will burn any ship that tries to pass through it, Iranian media reported, quoted by Reuters.
“Risk-off trading is likely to dominate in the short term. The US dollar should attract buying flows amid increased risk aversion and higher energy prices, and the Swiss franc is expected to follow suit. In contrast, emerging market currencies appear vulnerable, especially those of countries that are large net oil importers. Typically, increased geopolitical risks only cause temporary disruptions, and markets recover relatively quickly after the shock fades. However, developments will largely depend on several uncertain factors, in particular the duration and extent of the conflict, as well as the situation in the Strait of Hormuz. A complete suspension of traffic through Iran’s main shipping lane would probably pose the biggest risk to markets and could push oil futures (CFDs) towards the $100 per barrel mark,” Ebury analysts say.
According to the cited source, a sustained rise in oil prices would negatively affect the single currency, as Europe is a net energy importer, but the evolution will largely depend on the speed with which the conflict is resolved. At the same time, analysts show that the US dollar is appreciating after the attack on Iran, safe-haven assets and commodity-linked currencies are performing better, and volatility on the foreign exchange market remains relatively moderate.
“Early signs indicate that the impact on financial markets will be relatively limited, especially as investors had already anticipated a possible escalation of tensions. The fact that the attack took place outside trading hours also helped temper the initial reaction – Saudi Arabian markets fell by only 2% over the weekend,” Ebury reveals.
In Asian market trading on Monday morning, investors bought safe-haven currencies such as the dollar and the Swiss franc, but movements have been moderate so far. Oil has registered a more pronounced increase, over 10%, amid information that the Strait of Hormuz – essential for Asia’s oil supply – would be closed in the short term.
“In the coming days, attention will mainly focus on developments in the conflict. In particular, investors will watch whether the war will end quickly or be prolonged and whether the Strait of Hormuz will remain closed to shipping. In addition to developments in Iran, traders will also carefully follow the US labor market report, scheduled for Friday. Further interest rate cuts by the Federal Reserve are less likely in the absence of a sustained deterioration in labor market conditions,” the analysis quoted by Agerpres also shows.
Normally, this week’s focus would have been on the jobs report, due out on Friday. “We expect it to continue to show moderate job growth, with no signs of mass layoffs and with wage growth solid but not exuberant, in line with recent trends. Producer price data confirmed last week that there is no clear sign of a downward trend in inflation, with inflation remaining above target. Higher oil prices are not helping, but the US’s status as a net exporter means that overall this is currently having a positive effect on the dollar,” the analysis says.
Given that the dollar has maintained its status as a safe-haven asset during times of geopolitical conflict, it is expected that its downward trend will temporarily stop in the coming weeks. The extent of the appreciation, however, will depend largely on the duration and extent of the conflict. “While the top leaders of the Iranian Revolutionary Guard Corps (IRGC) have been eliminated, it remains unclear whether we are witnessing the beginning of a historic regime change or whether successors will quickly emerge to fill the power vacuum. Any signal in the latter direction would further support the dollar,” Ebury analysts point out.
As for the eurozone, preliminary inflation data (CPI) on Tuesday should confirm that the European Central Bank has managed to bring inflation back to its target. Geopolitical risk could put pressure on the euro in the short term, but it is worth noting that most of the crude oil shipments through the Strait of Hormuz are destined for Asia, not Europe. However, a sustained increase in oil prices would negatively affect the single currency, as Europe is a net energy importer and the terms of trade would deteriorate.
“The evolution will depend to a large extent on the speed with which the conflict is resolved. According to President Trump, operations in Iran are “ahead of schedule”, but there are still no signs of negotiations or a ceasefire. On the other hand, neither Russia nor China seem willing or able to actively support Iran, which is a relatively favorable signal for markets,” analysts at the global financial services firm also said.