A curious thing happened in the markets this week, and it can provide an inditation for a shift in trends, particularly affecting the Forex market. Prior to the market close on Friday, both US and Iranian officials said that the Strait of Hormuz was open for transit, leading to a surge in markets and drop in crude prices. But, over the weekend, it emerged that there really wasn’t an agreement, and the Strait is still closed.
Naturally, on Monday there was a reversal in the markets. But not quite. Crude prices jumped, but did not return to the same level on Friday. Equity markets in Asia were also positive, despite the region being the most dependant on the Gulf region for energy (at least before the war – but, more on that later). Europan stocks were in the red, and the Euro declined, giving the dollar index a boost. However, when looking at dollar yields, they also did not return to Friday’s level.
The Situation is Even More Critical Now
This development in the market is striking, because the deadline for the ceasefire has only gotten closer. And uncertainty has actually increased since Friday. The two-week ceasefire ends on Wednesday, and there is uncertainty if even the two sides will meet. Before the weekend, there was fair amount of confidence that US and Iranian leaders would hold face-to-face talks in Pakistan over the weekend. Now, US Vice President JD Vance is heading to Islamabad, but Iran has suggested it won’t send a delegation to meet him.
The about-face in Iran also sowed increased uncertainty into the situation. It was initially Foreign Minister Abbas Araghchi who said the Strait was open on Friday. But he was later contradicted by IRGC officials, with one going so far as to speak respectively of the Cabinet official. It is, after all, IRGC military units that are closing the Strait. The incident raises doubts whether the civilian government in Tehran will be able to assert control over the paramilitary organization even if it does reach some agreement with the US.
So, Why are Markets Not Panicking?
The presumption is that increased uncertainty would push the market back into risk-off mode. But it could be that the market simply is adjusting to the new reality, and geopolitical news is not driving a new reality. The presumption is that the war will be over soon in some capacity or another, which prevents upward spikes in crude prices.
Perhaps more crucially, the market is adapting to its new dynamics, and suppliers have sprung up to fill the gap in demand. This is similar to the energy crisis when Russia invaded Ukraine, and since then, the market has become more resilient to supply shocks. Crude prices have not reached 2022 levels in nominal terms, let alone when adjusted for inflation. As suppliers, distributors and buyers find alternatives, the market could settle into a new normal, meaning escalation fears might not drive up crude prices as dramatically as they did last month.
What to Look Out For
The main concern from the war is that it would dent economic performance and raise prices. The US saw the largest increase in gasoline prices on record in March. But the question is whether that will affect consumer behaviour, potentially undermining the dollar. A drop in consumer activity could raise the odds of a rate cut this year. Since the start of April, markets have been increasingly hopeful that the Fed will ease by December, with the odds now 50-50 for a 25 bps cut.
The consensus is for US March Retail sales to accelerate to 1.1% from 0.6% a month earlier. However, analysts noted a decline in used car sales in March, which could affect the outcome. The retail sales ex-autos data is still expected to rise to 0.9%, up from 0.5% previously.
