Safe havens well bid after US and Israel bomb Iran
News of the joint US-Israel attack on Iran broke after the close of trading in a week of relatively mild trading in financial markets.
Highlights:
US dollar rises following attack on Iran.
Ayatollah Khamenei killed, Iran retaliates.
Risk sentiment sours, oil rises.
Safe havens, commodity currencies outperform.
FX market volatility is rather contained.
Iran developments, NFP report to be watched.
Early signs are that the fallout in financial markets will be relatively limited, partly as investors had already been pricing in a flare-up in tensions to some extent. The fact that the attack occurred when markets were closed also helps matters – Saudi markets dropped just 2% over the weekend. While investors bought the safe-haven currencies like the dollar and the Swiss franc in early-Monday Asian trading, the moves have been contained so far. Oil is up more sharply, over 10%, on news that the Strait of Hormuz, the oil lifeline for Asian markets, will be essentially closed in the short term.
For the next few days, the main focus will be war headlines. In particular, whether the war resolves quickly or drags on, and whether the Strait of Hormuz will remain closed to shipping. In addition to the headlines from the Iran war, traders will focus on the US payrolls report out on Friday, as further Federal Reserve cuts are unlikely absent a sustained deterioration in the labour market.
USD
Ordinarily the focus this week would be the payrolls report this Friday. We expect it will continue to show modest job creation, little sign of mass layoffs, and healthy but not booming wage growth, following its recent trend. Producer prices confirmed last week that there is little sign of a downward trend, with inflation still above target. Higher oil prices will not help, though the US role as a net exporter means they are now, on balance, a net positive for the dollar.
Since the greenback has maintained its status as a safe haven in times of geopolitical conflict, we expect its downward trend to pause for the next few weeks. Again, the extent of the rally in the greenback will be highly dependent on both the duration and breadth of the ensuing conflict. While the main IRGC leaders have been killed, it is also not yet clear whether this marks the start of a historic regime change, or whether successors will merely plug the power vacuum. Any sign of the latter would also keep the dollar well supported.
EUR
Tuesday’s flash CPI report should provide further evidence that the ECB has succeeded in returning inflation to target. Geopolitical risk may weigh on the euro in the short term, but we note that most crude traffic through the Strait of Hormuz heads for Asia rather than Europe. However, a sustained increase in oil prices would negatively affect the common currency, as the continent is an energy importer and its terms of trade would suffer.
A lot will depend on the speed with which the conflict is resolved. According to President Trump, operations in Iran are “ahead of schedule”, although there are no signs of any negotiations or a ceasefire just yet. On the other hand, neither Russia nor China seem to be willing or able to aid their ally Iran, which is a good sign for markets.
GBP
Sterling is likely to suffer somewhat in the coming weeks. The Iran war has increased investment risk premia across the board, which tends to negatively affect the pound. Additionally, domestic political risks have significantly increased. The recent loss of a safe Labour seat to the far-left Greens has strengthened the most leftist Labour elements, increasing the risk to fiscal discipline and portending poorly for the gilt market and the pound.
On the plus side, interest rate support remains healthy and recent economic data has surprised on the upside. The Bank of England are broadly expected to slash rates again at the next MPC meeting later this month, but recent surprises to the upside in UK activity data, particularly the January retail sales report, suggest that the committee may err somewhat on the more hawkish side of expectations.