Weekly Market Update: Markets Rattled by Iran Tensions

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Market Update

U.S. stocks declined modestly last week, after a sharp rally at year-end and a new record high on the first trading day of the year, as tensions rose between the US and Iran following an airstrike in Iraq that killed a prominent Iranian general. US equities were down -0.1% for the week, while both European and UK stocks were down -0.3% on news of weak manufacturing data in December. The UK manufacturing sector worsened in 2019, with the sharpest deterioration in output in more than seven years, as political uncertainty weighed on orders. The best performing region over the period was Emerging Markets, which were up +0.5% for the week after optimism about a pending US-China trade deal supported sentiment. President Trump tweeted that he would sign a phase one trade deal at the White House on January 15. The People’s Bank of China also cut its reserve requirement ratio by half-point, injecting nearly $115 billion into the Chinese economy. Both UK and US 10Y yields were down across the week, closing the period at 0.740% and 1.792% respectively. Post the airstrike on Iran, a jump in oil and gold prices appeared to be the most immediate result. In US Dollar terms gold was up +2.8% at $1,552 per ounce last week, and the oil price climbed +2.2%.

CIO Analysis

The year started with a match in the Middle East powder keg. The killing of a top Iranian general in Iraq by US forces has sent chills across markets and oil prices spiked at the end of last week. Long term, geopolitically, Soleimani’s death may prove an important moment. It fuelled Shia resentment of US forces in Iraq, with the local parliament attempting to delegitimise their presence, further driving Iraq into the embrace of Iran. Iranian leaders have felt that justified to restart uranium enrichment. For Mr. Trump it might also be an internal win, as he showed military strength during a re-election year and possibly dodged a “Jimmy Carter”, or worse, a “Benghazi” moment with the US embassy in Iraq. Exciting as this story may be, it will probably have little effect on risk assets, unless things escalate dramatically. For one, while oil prices spiked, they are still beneath last April’s levels. West Texas Crude at $65 may stoke some short term inflation (central banks tend to ignore oil prices when considering inflation), but at current depressed CPI levels this is not a threat to central bank accommodation, the key driver of risk prices. The market’s knee-jerk reaction to Middle Eastern tensions dates back to the 1970s, when an oil embargo exacerbated economic pressures and was largely blamed for a recession and runaway inflation. Why is now different? Because back then Saudi Arabia, the world’s largest oil producer, drove oil prices up. Today, Sunni Saudi Royals are best served with stable oil prices. Iranian production has already been discounted away by renewed US sanctions. Loss of Iraqi oil could put upward pressure on prices, but Saudis could always balance that by turning on the taps, in exchange for continued American pressure on arch-enemy Iran. Also shale gas has been a game changer, as the US is now a net energy exporter, so the world’s biggest economy is less affected by oil price spikes. So unless we see some meaningful escalation from where we are, we would treat this as a low risk event for our asset allocation. 

David Baker, CIO

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