Geopolitical Shock Rattles Markets; Oil Surges, Investors Turn Cautious Amid Middle East Escalation – Michael Brown, Pepperstone

By Michael Brown, Senior Research Strategist at Pepperstone

DIGEST – Conflict in the Middle East has triggered fresh geopolitical uncertainty, causing a choppy and risk-averse start to the trading week, with headline-watching set to be the ‘order of the day’ for now.

WHERE WE STAND – Two months down, ten to go; how the year is flying by!

At risk of stating the obvious, it certainly hasn’t been an especially calm year thus far, with calmness also not being an adjective one can reasonably use to describe developments over the weekend.

Yes, we start the week with geopolitical events ‘front and centre’, after a joint US-Israeli operation to conduct missile and air strikes in Iran begun early on Saturday morning. The situation is, as is so often the case with these sort of things, incredibly fast-moving and fluid, however at the time of writing attacks by both sides remain ongoing, with the US and Israel conducting attacks across Iran, and Iran firing missiles not only at Israel, but also various US military installations across the wider Middle East region.

By far the most important development, though, is that Iranian Supreme Leader Khamenei has been killed, with President Trump noting that ‘most top Iranian decision makers’ have also perished. This, quite obviously, creates something of a leadership vacuum in the country, and is in keeping with Trump’s stated mission aim of regime change.

For financial markets, it is obviously energy where the primary focus lies. Again, at the time of writing, there appears to have been little-to-no impact on crude infrastructure within Iran, while the pivotal Strait of Hormuz remains open, even if maritime traffic using the waterway has thinned out significantly owing to clearly heightened tensions in the region, in turn resulting in a spike in insurance costs.

Speaking of markets, the week has started in a predictably volatile and risk-averse manner, as participants react to the weekend’s developments. Importantly, it is not only the risk of escalation, or broader conflict, that markets must now discount, but also the considerably wider range of potential outcomes that now exist, given kinetic action is underway. This wider range, unsurprisingly, makes accurately pricing risk incredibly difficult, if not impossible, hence leading to a ‘de-risk now, ask questions later’ approach for most.

As for specific movers, Brent gapped as much as 12% higher as markets resumed trade for the week, though the initial move has since been cut in half, with the front future slipping back beneath the $80bbl handle.

Elsewhere, some degree of the initial risk aversion has also faded, with gold trading firmer but off overnight highs; spoos having trimmed declines to less than 1%; and, Treasuries actually trading softer, led by the long-end of the curve, likely a result of inflation expectations being boosted by the surge in energy costs. This overall theme has been mirrored in the FX space, where the Aussie and Kiwi both trimmed a chunky gap lower to now trade flat on the day, and where the remainder of the G10 complex is relatively sanguine, all told.

One other thing that I would flag, here, is that, if history serves, geopolitical events tend not to be a trigger for durable or long-lasting moves in any asset. Typically, once markets have discounted the initial shock factor of whatever event has taken place, focus relatively rapidly returns to the fundamental drivers and narrative that was in place beforehand. With that in mind, I’d be fading any significant equity downside that we may see given that the bull case remains very robust indeed.

LOOK AHEAD – While geopolitical events will, of course, prove this week’s main focus, the economic calendar is nonetheless a busy one.

Friday’s US labour market report highlights proceedings, with the economy set to have added +60k jobs last month, and with unemployment set to have held steady at 4.3%. It’s tough to imagine, however, the figures materially moving the needle for the FOMC, with policymakers seemingly content with a ‘wait and see’ approach for now, after even Governor Waller, who dissented for a 25bp cut last time out, signalled a degree of comfort with standing pat for the time being in recent remarks.

Besides the jobs report, we have a host of PMIs to get through, with manufacturing surveys due today, followed by the services figures on Wednesday. Sandwiched between those, is the latest eurozone ‘flash’ inflation data, where headline CPI is seen having remained at 1.7% YoY last month, with the core figure also likely unchanged, at 2.2% YoY. Other notable releases this week include January’s US retail sales print, as well as Q4 Aussie GDP, and CPI from Switzerland.

Away from data, another busy week of central bank speakers awaits, including remarks from ECB President Lagarde (today) and BoC Governor Macklem (Weds). The earnings slate, though, is somewhat lighter, with reporting season effectively now being at an end. That said, reports from Target (TGT) and Broadcom (AVGO) may attract some attention.