By Michael Brown, Senior Research Strategist at Pepperstone
DIGEST – Markets went from max risk-off, to max risk-on, in the space of about 18 hours yesterday, amid another day of heavy geopolitical news flow, with said headlines set to remain in focus today.
WHERE WE STAND – I’m not entirely sure where to start when it comes to yesterday.
The day begun with my waking up at about 1am to a cacophony of market alerts, crude benchmarks barrelling higher, stocks falling off a proverbial cliff, and a general vibe of ‘Armageddon’ to the price action. The day ended with the equity dip having been bought convincingly on both sides of the pond allowing stocks on Wall St to notch notable gains, the dollar having erased all of its earlier haven bid, Govvies well off intraday wides, and crude benchmarks settling back under $100bbl.
What was the trigger for that dramatic turnaround, I hear you ask.
Well, G7 countries signalling that they may release crude from their strategic reserves will certainly have helped, even if replacing a ‘flow’ (Hormuz) with a ‘stock’ (SPRs) is clearly a stopgap measure at best. Furthermore, we had a round of relatively positive comments from President Trump, who told CBS that the war is ‘pretty much complete’ and that the US is ‘very far ahead’ of the 4-5 week timeframe that was originally outlined. Per those same reports, Trump is reportedly also mulling a plan to ‘take over the Strait Hormuz’, presumably alluding to the potential for navy escorts to be provided.
Chuck all that together, and you end up with a pretty powerful combination. One where the risk aversion seen at Sunday’s open proved rather ‘over the top’, and was then coupled with this Pavlovian-like response among market participants, who’ve been conditioned not only to ‘buy the dip’, no matter how modest such a dip might be or how the macro backdrop may look. On top of that, the environment remains one where nobody wants to get ‘caught short’, lest those in charge miraculously start to act rationally, and ‘solve’ whatever the prevailing issue du jour may be.
That said, it remains the case that, for the time being at least, everything hinges on geopolitical developments, chiefly the status of transit (or lack of) through the Strait of Hormuz, and the duration that it could remain impassable. This, in turn, will determine the scale and duration of any inflationary impulse that we see, the degree to which growth headwinds are posed, as well as any potential central bank response. On that latter point, my base case remains that the majority of policymakers seek to ‘look through’ the temporary impact of higher energy prices on headline inflation metrics, and that the market pricing both BoE and ECB tightening this year is unwise.
Zooming out, though, while positioning is clearly skewing the signal sent by STIRs to a huge degree, the fundamental issue here is that the distribution of potential geopolitical outcomes is simply enormous right now. One can make a case for anything from ‘this ends right now’ to ‘this drags on for years’, and almost anything in between, with that whole spectrum being entirely plausible right now.
This wide distribution, in short, means that there is massive uncertainty as to which path will be taken, and in turn leads to it being almost impossible to accurately price risk. It is, hence, logical, that participants have sought to adopt something of a more cautious stance, taking down risk exposures, cutting position sizes, and reducing the duration for which trades are held.
The key question, of course, is for how long does that remain the mindset? To me, changing that overall stance probably doesn’t need conflict to come to an end, but it likely does need some sort of an ‘off-ramp’ to become visible, or at the very least flows through Hormuz to be restored to some degree.
As a result, then, unless either of those latter points were to become clear, the overall tone should remain cautious, and cagey, with participants continuing to position themselves defensively – benefitting the USD, primarily, as the only real haven in town right now.
Still, while that is likely to be the case in the short-term, on a more medium-term view I remain constructive when it comes to equities, with the underlying bull case remaining a solid one, albeit with participants needing geopolitical noise to be dialled down a few notches before being able to refocus on it.
LOOK AHEAD – Data continues to matter little in the grand scheme of things, and there isn’t much of it on the docket today in any case. The US provides last month’s existing home sales report, which is never a market-mover at the best of times, in addition to selling 3-year notes, which should be absorbed relatively well.
Of more interest are likely to be earnings after the close from Oracle (ORCL), with the stock having more than halved since the September peak amid worries over debt-financing, and broader fading of the ‘AI euphoria’. Options on the stock price a punchy +/-10.5% move after market, with the bar likely being a very high one indeed to reassure participants that all is ‘fine and dandy’, amid ongoing worries that the companies has simply expanded too much, too quickly.
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