By Michael BrownSenior, Research Strategist at Pepperstone
DIGEST – Geopolitical events were again the main market driver last week, and should remain so this week, though a bonanza of G10 central bank decisions will also attract plenty of attention.
WHERE WE STAND – I suppose that ‘more of the same’ rather sums up what we saw on Friday.
Geopolitical events remain firmly in the driving seat, as participants continue to closely monitor developments in the Middle East. Thus far, there remains little sign of any de-escalation from either side, while weekend US strikes on Kharg Island may well embolden retaliatory action on energy infrastructure in the Gulf, even if the US have stuck solely to military targets on Kharg for now.
In any case, with conflict now entering its third week, I thought it may be instructive this morning to recap how I’m currently viewing things, on the proviso that the situation remains highly fluid, to say the least.
At a high level, consensus, and my own stance, clearly must now shift from this being a relatively clinical operation that proves somewhat short-lived, to one that is likely to be much more drawn out, not only as the US continue to move more military assets to the region.
That said, I’d argue that the impact of geopolitical events on markets, and the macro outlook, hinges more on when transits through the Strait of Hormuz begin to normalise, than it does on when hostilities come to an end – the longer the Strait is impassable, the tighter commodity supply will become, thus the higher prices will likely go, and the greater the inflationary impulse that will follow. Still, the timing of the two need not coincide, though we all clearly hope that conflict does indeed end sooner rather than later.
I suppose that covers off my commodity view, where a mechanical daily grind higher in crude benchmarks is the baseline scenario for now, unless and until material progress is made in ensuring safe transit through Hormuz – either via navy escorts, or some other means – which could relieve some degree of tightness in the market.
Elsewhere, while my equity view has shifted to a cautious stance in the short-term, I continue to view present events as unlikely to lead to a longer-run bearish turning point, given that the underlying fundamental backdrop remains a favourable one.
That said, participants have understandably sought to take down risk levels amid geopolitical uncertainty, and continue to struggle to price risk accurately, given both the wide range of potential outcomes, and ever-changing statements from the White House. This poses a headache for market participants – we can discount ‘bad news’ or ‘negative catalysts’ in an orderly manner, then move on; we can’t do the same with this endless headline noise, which then leads to the choppiness and volatility that we’ve seen in recent weeks.
Still, while that’s the case, there is still also a broad mindset among participants not to get ‘caught short’, given both expectations and precedent that a Trump U-turn could be right behind the next ‘Truth Social’ post, putting a floor under the market to some extent, even if a durable rally likely needs Hormuz to be ‘solved’, as mentioned above.
While uncertainty remains so elevated, the dollar is set to remain the only haven that really ‘works’, with the DXY having ended Friday north of the 100 mark, and looking well-positioned for further gains. In the FX world, one can’t buy the Swissie with the SNB set to lean against appreciation in the currency, while the JPY is also out considering how sizeable an energy importer Japan is. Elsewhere, buying Govvies as a haven in an inflationary environment is a bit of a fool’s errand, though bets on Fed/ECB/BoE rate hikes are wide of the mark in my view, and gold continues to behave more like a momentum-driven risk asset than anything resembling a ‘store of value’, though a test of the 50-day MA at $4,950/oz should be well-defended by the bulls.
With all that said, the other valuable thought exercise is to consider whether there are any market levels that might force the Trump Admin into a ‘reverse ferret’. Recall, Trump’s spent a year – if not more – expressing a desire for higher equity prices, lower yields, a weaker dollar, and cheaper energy. Right now, the exact opposite of all those is occurring!
Clearly, the view in the Oval Office may be that this is a short-term price worth paying for a more stable Middle East, and global, environment in the long-run. I’d imagine, though, that that calculus could shift rather rapidly if spoos were to trade under 6,500, or more importantly if the benchmark 30-year yield were to rise north of the 5% mark, given that one, or both, of those eventualities could see the ‘wealth effect’ slam into reverse, setting off a rather ugly sequence of events that would amplify downside risks facing the economy at large.
LOOK AHEAD – Geopolitics will remain the main focus for market participants this week, but a busy calendar awaits regardless.
Something of a central bank bonanza is in store, with seven G10 policy decisions due this week. Besides the RBA, who will likely deliver a 25bp hike overnight, all are set to stand pat, with the general approach set to be a ‘wait and see’ one, amid the fluid situation in the Middle East, and as upside inflation risks remain essentially unquantifiable at this stage. Still, I’d expect the over-arching message from policymakers across the globe to be one of ‘acting as appropriate’ to ensure that inflation remains at target levels over the medium-term, though explicit guidance towards policy tightening is unlikely from most, besides the RBA & BoJ, for now.
Elsewhere, the data docket is highlighted by jobs reports from here in the UK, and Australia, as well as a smattering of second-tier stateside releases. Meanwhile, there’s also a 20-year Treasury bond auction pencilled in for Tuesday, as well as earnings from Micron (MU) that may attract some attention after the close on Wednesday.
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