Markets are showing disappointment over the failure to end the war in the Middle East over the weekend. Brent shot up to almost $105 per barrel and gold dropped below $4,700 with the dollar being the clear winner. However, those are relatively modest shifts in sentiment compared to recent market moves.
Overally, markets appear to also be cautiously optimistic thatthe US-Iran deal can be reached soon enough to prevent an economic meltdown. This has kept a lid on crude prices. In fact, safe havens are starting to fade as traders have time to digest what happened, and what could be expected in the coming days. This is setting the stage for a potential market reversal.
Iranian Ports Blockaded
US and Iranian delegations left Islamabad, Pakistan on Sunday saying they hadn’t reached a deal, but leaving open the possibility for more talks. According to Pakistani mediators, the main sticking point was Iran’s nuclear ambitions, although neither side offered a detailed account of what happened. This allowed for rampant rumors about how close or distant the sides were to reaching a deal. Regardless, the main takeaway for the markets is that talks are ongoing.
Afterwards, US President Donald Trump put more pressure on Iran, announcing a blockade of the Strait of Hormuz. However, the US Navy later clarified that it was a blockade of Iranian ports, aimed at ships that paid a “toll” to pass through Iranian territorial waters. US forces would not interdict ships sailing through the normal route that transits Omani territorial waters. By early Monday, there hadn’t been any renewal of shipping through the Strait.
Getting the Mines Out of the Way
Another issue is related to uncertainty if the normal channel has been mined. There have been rumors to that effect, with Iranian officials both saying it has and has not been mined. There were additional rumors circulating that Iran had placed mines in the channel, but was unable to remove them. This was seen as an explanation for why Iran was refusing to comply with one of the main conditions of the ceasefire, which is to open the Strait. However, Iran has not attacked any vessels that have attempted the crossing.
Meanwhile, two US Navy destroyers transited the Strait without impediment, a potential indication that the area could be cleared of mines and shipping could resume. However, as major insurance providers refuse to offer coverage to ships crossing the Strait, many major shippers are opting to not take the risk.
How the Market Will React
The bump higher in crude on Monday represents a risk premium among markets that are worried about an escalation. Both sides threatened to resume hostilities if a deal is not reached in the allotted time. However, the relatively small increase suggests that traders are pricing in a high likelihood that the US-Iran deal will be reached. Israel and Hezbollah are expected to hold talks early this week to end that side of the conflict, which could be seen as a positive step, and weigh on crude prices.
If there are few signs that the situation will resolve in the short term, then Brent could drift higher towards $120 again. On the other hand, Gulf states have resumed production through alternative routes while the ceasefire holds, helping to plug the supply gap. This could leave Brent drifting lower, until there is a clear sign that tankers will be able to transit the Strait without any major impediments.