Financial markets are in increasing disarray as the war in the Middle East drags on. Possibly, some of last week’s losses were tempered by hopes that the situation would be resolved quickly. But, after US President Donald Trump signalled the possibility of a wider war and the hardliners in Iran consolidated power over the weekend, traders are diving for safety.
The biggest gainer has been the US dollar, as the country is a net oil exporter and is less likely to be affected than other countries. Asia is in crisis as the Strait of Hormuz remains impassible (although Iran claims to have “full control” and it is open, ships in the area have been hit with missiles and drones). Over 80% of the crude that comes out of the Persian Gulf goes to Asia, with countries like South Korea and Japan wholly dependent on exports. Refineries in Southeast Asia are already facing shortages, as diesel fuel prices spike. This could have wider implications, as diesel is the basis for jet fuel and is a key component of the industrial energy matrix.
Quick to Shut Down, Slow to Restart
Already, Kuwait and the UAE are slowing down production as their storage facilities are quickly filling up. Unable to board the crude on ships, oil fields will have to be shut down. The problem is that restarting an oil facility after a shutdown can take weeks or even a month. So, if Persian Gulf nations are not able to get crude out through the Strait soon, their oil production could go offline for an extended period, causing a crisis even if the war in Iran ends soon.
Brent spiked to almost $120 at the open on Monday, but retreated as reports that the IEA, G7 nations and OPEC were working on a coordinated release of oil reserves to plug the supply gap. As much as 400 million barrels could be released, more than double the amount added to the supply in the wake of the Ukraine war. Almost 15 million barrels per day would pass through the Strait, meaning that the release could cover a little over a month of lost supply.
A Longer War Risks the Global Economy
Over the weekend, Iran chose Mojtaba Khamenei to replace his father as the new Supreme Leader, a sign that hardliners have consolidated power. Investors were spooked by pictures out of Iran showing huge oil fires, after Israel bombed fuel depots around the country. Reportedly, US officials were dismayed by this action, the first sign of disagreement between the two countries, as the White House is trying to avoid a popular backlash. Iran threatened to attack oil infrastructure in Gulf states as a reprisal, which contributed to higher oil prices.
One of the main concerns is that higher crude prices will filter through to broader consumer prices, pushing up global inflation. This could be enough to tip the world outside the US into a recession. The concurrent drop in stock and gold prices suggests a liquidity crisis that typically precipitates a market rout.
The Dollar Keeps Rising
Traders looking for safe havens have piled into the dollar. Higher inflation means that central banks won’t be able to cut rates, and might have to actually start hiking. This means those economies could come under renewed pressure as monetary policy becomes restrictive. The ECB is now expected to hike by 50 bps by the end of the year, and the BOE’s next move is expected to be a hike.
Meanwhile, markets are still expecting two rate cuts from the Fed, though the odds are falling. This relatively modest hawkish shift has also weighed on gold, but is contributing to dollar strength. As long as oil prices remain elevated, investors could continue to support the greenback as the war drags on.
