Macro Dragon: New Year Kicks off with Middle East Conflict

2020-Jan-06

Macro Dragon: New Year Kicks off with ME Conflict (USA / IRAN)

Before we get into it, for those that are back – or on the way back in – from what was hopefully a restful year end holiday break, Happy New Years!

Let me sincerely (hand on liver) wish you, your families & teams the best of 2020. May your health, vigor & experiences be excellent & full of fun + laughter. May you continue to grow & develop yourself. May you be awash in gratitude & contribution, & fall [tail] backward into more money than Bezos.

We’ll be shaking things up from KVP’s side, so expect a lot more trade views going forward, as well as 20 long-term trades views for 2020 – which KVP will do a special piece & mini-series on.

Ok let’s get after it…

Implications of US assassination strikes in Iraq:

So for those who may have not been in last wk, or caught the news over the wkd – we had a US drone strike just outside Baghdad airport, that killed an Iranian General by the name of Qassem Soleimani. The strike was taken as pre-emptive measure, as according to US intelligence Qassem has a lot more US targets & attacks in the making. Its worth noting that on the ground in Iraq, the US has lost ground to Iranian influence month in & month out, the escalation of the attack on the US embassy even within Baghdad green zone seemed to have been the tipping point of showing that the US means business. According to Trump

"We took action last night to stop a war. We did not take action to start a war”

Here is a link to the rest of his statement on the attacks.

Qassem was seen as most likely the 2^nd most powerful individual in Iran – under Iran’s supreme leader Ali Khamenei, who its worth noting is 80yrs old – and was both revered & hated across the region. He was basically the mastermind behind Iran’s strategic military in the region and has been associated as being instrumental in the fight against ISIS, as well as also strikes against ships & oil refineries linked to the Saudis. His experience goes back even to the Iraq-Iran war.

The bottom line, this was a major chess piece that has been taken off the board. It is being seen as a huge blow & lose to the Iranians – will be next to impossible to replace someone of that caliber – with potential ripples internally and likely seen as a big win to the US as well as the Iraqis that are tired of Iran meddling in their home affairs & politics.

The main consensus view post the event is that this is a major escalation by the United States & Iran will strike back – they have already sworn “revenge” & Trump has already warned that the US will respond to any further attacks & has a number of sites already set out.

We saw that risk-off mode close the first wk of the year off, as equities fell -0.71% on S&P to 3234, gold +1.51% to 1552 & oil +3.6% to 68.60 on brent, +3.1% to 63.05 on WTI & the yen strengthened as USDJPY dropped -0.44% to 108.09

And this early doors Asia Mon Morning – the trend continues in risk-off mode. With US EQ futures down c. -.35-40bp yet off their lows, DollarYen is back above 108, yet oil, gold & bond futures continue to climb higher.   

Note the official Saxo House View on this situation is to wait & see how things play out as its still quite fresh & dynamic. More importantly worth bearing in mind where we are in the business cycle (late & the expected bounce in 1H20 is still questionable), the huge gains over the last few years, including 2019 stellar returns (+29% S&P) & overall increased geopolitical risk. Basically, the party is set to stop at some point – que though is this one of the things that starts us on that slippery slope?

KVP initial instincts is that it’s going to take a lot more than an escalation of US/Iran to take us into much more serious risk-off i.e. -10% on the S&P, so taking us from the ATH of 3258 on Jan 2, to 2910.

Here are a few things that leave KVP hesitant to jump on the risk-off wagon, we’ll touch on the risks to this view. Note everything discussed here is tactical & near-term, by no means does KVP think any of this is structurally significant for markets.

• Not everybody is back on their desks from year-end holidays & rest – so any price action we have seen so far has been on poor liquidity & participation. In such situations, default question is to see why the moves should not be faded – buy equities, sell oil, sell gold, etc? 

• One has to take the media rhetoric with a big bucket of salt – the media is extensively negatively biased towards anything Trump says or does. So the fact that the vast majority of the coverage are along the lines of saying this is a mistake & likely the biggest fumble since the 2003 Iraqi war… roll back the lack of objectivity. Seriously the biggest fumble since the 2003 Iraqi war?
  • How about Obama not holding Syria's Bashar to the line on use of chemicals against his own people...
  • Trump pulling out of the US/Iranian agreement in the first place…
  • I could go on, bottom line very few journalists, analysts & investors really understand the middle east & the vast majority of them would not give Trump credit for anything. As we’ve said before, the dude could walk on water & they’d accuse him of not being able to swim. If he turned water to wine, they’d say they wanted beer, etc…

• There is not going to be any war. A war in KVP’s book, assumes that there are relatively equal players on the battle field. The US military could orchestrate crippling strikes that the regime may never recover from – this may even be a scenario that is on the table for US Military & Political strategists, “please give us an excuse”. We could go from strikes in Baghdad, Iraq, to strikes in Tehran, Iran in a heartbeat - if  the US feels that the Iranians have overstepped

• It’s also worth keeping in mind, that the Iranian regime has been devastated & under a lot of pressure since Trump reneged on the deal that had been struck by the Obama administration.

• Iran has to tread carefully, yes they will retaliate – as they have to save face – yet they cannot retaliate too hard or things could get that much challenging for the regime.
  • So Iranian vs. US troops & targets in Iraq, a few ships targeted, etc… is probably “ok”.
  • What is probably not “ok” is missile strikes out of Iran or from Iranian proxies towards US bases & US targets, similar to the oil refinery strikes that we saw in Saudi Arabia. Blocking the straights of Hamas is also going to be a suicidal move, not to mention potentially the best oil fading opportunity move of a lifetime
• Sometimes an increase in conflict is actually what leads to an end in conflict – time is not on the regimes side & it continues to be vastly unpopular for a growing number of its citizens. There is virtually no one out there, thinking that this could actually lead to better days for the Middle East.

• A deal can be struck very quickly & easily with Trump – i.e. he broke the previous deal, just because it was Obama’s, it could easily be window dressed “a la phase one” style. Question is of course the political capital & willingness of the Iranian regime to get to the table.

• We still have a Fed with room to cut if things were to potentially get worse & super accommodative central banks globally.

• At some point (could be today & its likely this wk… latest nxt wk), oil & gold are a tactical fade – yet likely the easiest plays are to look for a tactical buy the dip in equities, sell the spike in EQ vol (VIX +12.4% to 14.02) & decide whether or not to lighten up on duration (i.e. KVP would have have a core long position in bonds either way)

• If we got a measured response from Iran, it would be much easier to play the bounce up in risk sentiment. Question is of course timing, magnitude as well as number? of response/s from Iran.

Let’s talk risks to KVP’s view…

What could the risks be to KVP’s view – what could really cascade us further into an outright route in global equities?

• Iran makes a strategic blunder – remember their best placed chess player for these situations is no longer in the game – by doing a combination of direct missile launches on US bases & targets, as well as looking blocking the straights of Hamas. Again KVP would still look to buy the dip post this, but going into we’d see a drawdown no doubt

• Something else elevates the uncertainty in markets – perhaps its North Korea’s Rocket Man  back into action with missile launches that sinks a US/Allied Navy vessel or hits a US base in Guam

• We get a sniff that the Fed make actually be thinking about hiking and/or a massive inflation beat in the US

• We get a string of very poor US economic data (ISM Non-Mfg, NFP, UR, etc… all miss big time) which cascades the current near-term negative sentiment

• Break-down of recent US-China phase one agreement

WK Ahead:

So post last week’s less than stellar manufacturing numbers - pretty big miss in the US ISM 47.2a 49.0e 48.1p, albeit EZ beat at 46.3a 45.9e – this wk will be on the services side. Is the US consumer still ticking along strongly?

In the US look out for factory orders, ADP jobs data & of course super Friday: NFP 150k e 266k p, U/R 5.8%e 5.9%p & AHE 0.3%e 0.2%p

China will also have CPI 4.7%e 4.5%p & PPI -0.4%e -1.4%p due, in addition to New Loans & M2 Money Supply – again bear in mind Chinese New Year is early this year & falls in the tail end of Jan. So there tends to be a lot of seasonal effects, which makes the previous PMI figures that more worrisome.  

Euro-Zone will have inflation, retail sales as well as industrial production & factory orders out of Germany.

Australia will have building approvals, trade balance & Retail sales.

Our excellent analyst Eleanor down in Sydney, has put out some great works on the devastating fires that Australia is currently battling – with no potential rain until perhaps late Feb, things are looking dire. To say that Global Warming is front & center as we go into 2020 is an understatement with Australia Burning, Delhi shivering & even Jakarta no stranger to wet weather calling it “Not ordinary rain”.  

Central bank wise, no major scheduled decisions on the calendar. Yet do watch out for quite a few Fed speakers this week.   

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Have a great, profitable start to the year everyone. Best of luck in 2020.  

Namaste,

-KVP

**

On The Radar Today:

Its really all about Final Services today…

• CH: Caixin Services 53.2e 53.5p

• UK: Final Services 49.1e 49.0p

• EZ: Final Services 52.4e/p, PPI

• US: Final Services 52.2e/p [ISM Non-Mfg. will be on Tue, 54.5e 53.9p]

What We Are Reading From #SaxoStrats:

• Jakobsen & SaxoStrats team with our 2020: Outrageous Predictions

• Ole on initial cut on the conflict: Middle East tensions drive oil & gold higher

• Peter-G on equities in the new year: What to expect in 2020?

• Eleanor’s latest on China: Patchy Activity Keeps Policy Makers in Easing Mode

• Hardy latest FX Breakout Monitor: Geopolitical concerns washing over currencies