Market volatility is turning investors’ heads as the Middle East conflict intensifies and enters a sixth day. Earlier reports from the New York Times that Iran was ready to negotiate were later dashed by Iranian authorities. Chinese financial institutions are scaling back their exposure to Middle Eastern debt – including Aramco – and despite US escort and insurance plans, traffic through the Strait of Hormuz reportedly came to a complete halt yesterday, with no ships transiting.
Donald Trump says that the US is doing very well in Iran, and investors are willing to believe him, hoping the conflict could move toward a resolution. But the news tell another story.
US and European markets were bid yesterday on the back of strong economic data. PMI data in Europe mostly hinted at faster expansion in economic activity in February, while ISM numbers in the US also looked solid – stronger activity combined with softening price pressures. The ADP report showed 63K new private jobs, higher than expected, though last month’s figure was revised down from 22K to 11K.
On the trade front, the US said it will raise the global tariff from 10% to 15%, but Europeans would keep their 10% tariff rate – whoop whoop – except perhaps for Spain. Trump said he does not want to trade with Spain anymore as the country is unwilling to get involved in the US/Israel conflict with Iran. But that apparently wasn’t an issue for markets – the IBEX rebounded 2.5% yesterday, while the Stoxx 600 recovered 1.37% on hopes that the Iran conflict could come to an end.
Frankly, I’m not sure why investors think so. There is no clear plan, missiles and bombs continue to fall, and oil and gas prices are trading higher this morning.
US crude is trading above $78 per barrel at the time of writing – near the highest levels since the Iran tensions began. European natural gas futures retreated 10%, but remain about 60% higher than last week’s levels. US natural gas futures remain steady – the US has been the world’s largest gas producer since the shale boom and benefits from relative energy independence. It is also the largest LNG exporter. The EIA had estimated – before the Iran conflict – that US gas prices would rise this year due to growing exports, but the US could decide to curb LNG exports to keep domestic prices in check. That would be terrible news for Europe. China, on the other hand, reportedly told its biggest refiners to halt diesel and gasoline exports.
So when I look at the news, I see one thing: escalating tensions.
Most US and European futures are down this morning – though losses are modest compared to earlier this week – while the FTSE is up, likely helped by rising energy prices. The Dubai Financial Market index, heavy in financial services and real estate, tumbled 5% after reopening for the first time since the conflict began – the exchange’s daily limit-down level.
Elsewhere, price action is mixed. The Nikkei is down 1.5%, the Hang Seng is up about 1% but struggles near its 200-day moving average, while the Kospi rebounds 11% today after yesterday’s 12% drop. Korean market moves are mind-blowing, and the amplitude alone signals that things are not going well. And I am not even talking about rising oil prices, which are outright negative for Korea, a country that imports about 97% of its energy, much of it passing through the Strait of Hormuz, where traffic reportedly halted yesterday. Price action therefore remains extremely jittery, and large gains – 11-12% intraday at the index level!! – are themselves signs of extreme volatility. And high volatility simply means high risk, including the possibility of significant losses ahead.
Globally, the rise in oil prices remains concerning. Higher energy prices could weigh on central bank expectations and push global yields higher. Rising rates would in turn pressure equity indices. The US 10-year yield continues to trend higher in Asia trading, along with Japanese and Australian yields. The US dollar is pushing higher after yesterday’s retreat. The EURUSD has slipped back below 1.16, while Cable is drifting toward 1.33.
The US dollar will likely remain in demand as long as Middle East uncertainty persists. The fact that gold hasn’t attracted stronger safe-haven flows suggests investors do not have many obvious places to hide.
So what’s next? It depends. Headlines do not point to a near resolution of the Middle East conflict, meaning the risk of further stress remains very much in play. Uncertainty will likely prevent global indices from recovering sustainably. If the conflict escalates, the dollar will appreciate further. Higher energy prices, priced in a stronger dollar, would weigh on global growth, with emerging markets likely among the hardest hit.
China today set its growth target at 4.5-5%, the lowest since 1991.
Oil exporters could diverge positively from importers in the short run. Mainland Europe, China, Japan, Korea and Taiwan are major oil importers, while the US, Canada and Brazil are among exporters. Of course, a prolonged conflict would eventually weigh on all indices – as slower global growth is bad news even for exporters – but in the short run, the pain could be heavier for economies dependent on imported energy.
There is one hope: the end of the conflict. Some investors appear willing to jump to the final chapter ahead of time – which is why we see strong gains on the smallest hints of good news. But there may still be more pain on the menu before a convincing rebound.
