By Michael Brown, Senior Research Strategist at Pepperstone
DIGEST – Sentiment was pressured on Friday, while markets appear downright ugly to start the new trading week, as benchmark crude prices break $100bbl, with participants remaining squarely focused on events in the Middle East.
WHERE WE STAND – Friday proved to be an ugly end to last week and, somehow, the start of the new trading week is looking even uglier.
Friday’s sharp souring in sentiment, and broader risk-off tone, was driven by a handful of factors. Namely, participants predictably seeking to de-risk their books into the weekend, with few wanting to ‘catch a falling knife’ once that got underway, while also having to digest a dismal February US labour market report, with a few further jitters over the state of private credit sprinkled on top for good measure.
Of those concerns, it is only geopolitical matters that participants are focused on this morning, with the weekend having seen no steps whatsoever in terms of de-escalation, and if anything actually seeing an intensification of the conflict, especially with domestic Iranian energy infrastructure having now become a target. This, coupled with the continued impassability of the Strait of Hormuz, and subsequent commencement of production cuts in various Gulf stats, has created a ‘perfect storm’ for crude benchmarks, with both Brent and WTI comfortably north of $100bbl to start the week, and up around 20% apiece at the time of writing.
It remains the case that almost everything else in markets is taking its lead from the crude space, not only as participants digest the commodity price shock, but also as a surge in energy vol triggers a broader degree of de-risking and de-grossing. In short, ‘sell first, ask questions later’.
This goes a long way to explain what else we see on the board, not only this morning, but also what we saw as last week drew to a close. Stocks continue to face stiff headwinds, with markets in Europe and Asia, specifically Japan, more vulnerable in the short-term given that those are heavy energy importers, and with those markets having vastly outperformed the US YTD, until the Iran war begun.
The same applies elsewhere. Govvies continue to soften as markets price higher near-term inflation expectations, and a more hawkish central bank policy path; gold remains more of a momentum-driven risk asset, than a haven, though spot holding north of $5,000/oz overnight is notable; while, in the grand scheme of things, the greenback remains the only haven in town, with neither the JPY (energy importer) nor the CHF (SNB intervention risk) looking especially attractive right now.
Zooming out, I think it’s important to recognise that almost everything we see in markets right now is the opposite of President Trump’s stated aims. On numerous occasions, Trump has noted his desire for lower oil prices, higher stock prices, a weaker dollar, lower rates, and a more dovish Fed. What he’s actually getting right now is higher oil prices, lower stock prices, a stronger dollar, higher rates, and a Fed that’s stuck between a ‘rock and a hard place’.
I’m not saying that means another infamous ‘TACO’ moment is on the cards – it’s rather different to end a war, than it is some tariffs – but these are surely variables that will be playing into the President’s thinking. Particularly, when every day Hormuz remains impassable, crude prices are likely to grind higher and higher. Couple with this the rather ambiguous aims for the US operation in Iran, which don’t appear to have quantifiable goals, and there is a world in which ‘mission accomplished’ could be declared simply in an effort to becalm financial markets.
Perhaps that may prove to be wishful thinking on my part. In any case, we are not at that stage yet, and for the time being at least there are likely to be few in markets seeking to ‘catch a falling knife’, barring a Trump pivot. Typically speaking, a move like this in the energy complex is one which can kick-off a spiral of hysteria and panic, where participants all seek to head for the proverbial exit door at the same time, as the macro outlook is turned on its head. Even if the shock proves short-lived, a desire among participants to reduce risk in a market with such high levels of realised, and implied, vol is highly likely.
On the whole, of course, the macro impact of the energy shock depends entirely on how long it lasts. Here, I would note that moves remain afoot to ensure safe transit through Hormuz, via insurance guarantees and US Navy escorts, with significantly higher crude prices likely hastening progress on that front. My view remains that all this is more likely to prove short-term market turbulence, as opposed to a longer-run turning point for markets and the economy, though the more protracted conflict proves to be, the more risks will tilt in favour of the latter, more bearish, scenario.
LOOK AHEAD – To a degree, it goes without saying that geopolitical events will remain the main driver of markets as we look to the week ahead.
Still, there are a few items of note on the data docket, which is highlighted by the latest US CPI figures. Both headline and core CPI are expected unchanged in February, at 2.4% YoY and 2.5% YoY respectively, though of course this data comes before the impact of the recent surge in commodity prices has made itself known, and hence will have little-to-no policy implications. The same goes for most US data this week, including the 2nd read on Q4 GDP, and January’s PCE report, both of which are due on Friday.
Elsewhere, we also receive GDP figures from the UK this week, which should point to a modest pick-up in momentum as the year got underway, albeit with the usual caveat that monthly growth data is incredibly noisy, and provides little by way of signal. The data docket is otherwise lacking anything especially interesting, though we do have a busy week of Treasury supply to work our way through, as well as notable earnings from the likes of Oracle (ORCL) and Adobe (ADBE).
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