Markets are still reacting to the US-Israel attack on Iran that started over the weekend, right in the window that had been anticipated. Crude prices jumped at the open, as was to be expected, given that the market hadn’t priced in the risk of the war starting just yet. However, the initial reaction faded as traders assessed the situation. What helped mitigate the circumstances is that OPEC+ met as scheduled on Sunday and announced a production increase starting in April.
Global markets are in retreat on Monday as traders jump into safe-haven assets, which has propelled gold higher. The dollar has also appreciated, suggesting it remains a key safe-haven asset despite recent talk of de-dollarisation. The Swiss Franc has also seen solid gains. How the market will evolve in the coming days depends on developments in the conflict, and there are some worth highlighting that are especially relevant to Forex.
“Ongoing” vs Making a Deal
US President Donald Trump confirmed US participation in the attack just a couple of hours after the first reports of explosions in Iran. In his speech, he said that the operation would be “ongoing”, a distinct difference from the pinpoint, single action seen back in June. On Sunday, he further clarified that the operation could last up to four weeks. But he also suggested that he was open to a deal that would lift sanctions on Iran if they were “pragmatic”.
This immediately brought up the idea of a “TACO trade”, where Trump puts on maximum pressure in the middle of negotiations to get concessions, and then backs off the threat when a deal is reached. This could mean the conflict might end before the four weeks are up. On the other hand, Trump said that Iranian officials were seeking to talk, which prompted a confused response from Iran.
No One to De-Escalate With
Iran’s Supreme Leader Ayatollah Ali Khamenei was killed in the initial attack on Iran, and there was no clarity on an immediate successor. Constitutionally, a three-person committee would govern, but at least one of the members (the President) was also killed. Several potential candidates for Supreme Leader have emerged. Trump said that some of the figures he hoped to work with in a new government in Iran were killed. Foreign Minister Abbas Araghchi repeatedly called for dialogue during the weekend. Security Chief Ali Larijani, who is seen as a potential successor to Khamenei, first said he hoped to resolve the nuclear situation through “pragmatic diplomacy”. Then, on Sunday, he said there would be no negotiation with the US. It’s not clear whether there is even someone in Tehran with the authority to reach a ceasefire deal with the US and Israel at this point.
Israeli and US strikes have targeted radar installations, as well as communications and command and control centres, consistent with an initial phase to secure air supremacy ahead of a prolonged campaign. This also makes it difficult for Iran to coordinate a response, or, indeed, to decide whether or what to negotiate. Almost immediately, Iran responded by launching missiles at multiple countries in the Middle East which have US bases. But countries without US bases, like Oman, also came under attack. In an effort to close the Strait of Hormuz, Iranian drones attacked ships off the coast of Oman and the UAE. Additionally, Iran-allied groups in Lebanon, Iraq and Yemen launched missile attacks of their own, leaving many analysts worried that the war could spill across the region.
Where Markets are Headed
The military operation is still in its initial phase, so there is considerable uncertainty about how it will evolve. Once there is clarity on whether the conflict will spread (and there are growing indications it will not), markets might price in the effect of a regional war that keeps the Strait of Hormuz closed for weeks. One additional aspect is that the war means the US is distracted, and this could make reaching a deal between Russia and Ukraine more difficult. Already on Saturday, there were reports that Russia was looking to walk away from peace talks, that if successful, might have brought more crude on the market.
The next issue is whether the Iranian government can consolidate its power or whether there will be another popular revolt. US Trump called for the people of Iran to “rise up”, which could lead to a protracted conflict in Iran, keeping crude prices elevated and disrupting global trade. On the other hand, if the regime can consolidate power and reach a deal similar to Venezuela (an option heavily hinted at by the White House), then crude prices could drop dramatically as Iran returns to the global crude market.
In the meantime, higher crude prices mean higher inflation, which could undermine the ECB’s dovishness and eliminate the chance of a near-term Fed rate cut. Gold would likely try to score a new all-time high.
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