Iran Risk Off Rush, What's Next
Summary: In a textbook risk-off rush, US stock index futures and Asian equities tumbled after Iran launched an attack on Iraqi air bases where US troops are stationed in Iraq. Treasuries, the yen and gold surged, along with oil prices, with gold rising above $1,600/oz for the first time since 2013 as tensions ratcheted higher in the Middle East.
After fleeing to haven assets, traders will now be in ‘wait and see’ mode in an attempt to gauge the scale and severity of the Iranian counterattack in order to assess the range of likely countermeasures from the US and whether there will be a further escalation in tensions.
Key to the US response will be casualty numbers. As yet, there are no official reports but Fox news are reporting no American casualties after the missile strikes as yet, although some Iraqis have been injured. In a conflicting report, Iran's military says it has killed 30 US soldiers in Iraq tonight. The key to the next move in markets will stem from the damage assessment and count of US casualties to determine President Trumps response function. Any US casualties will undoubtedly prompt an escalation from the US, so it is critical to see how this story develops. The Islamic Revolutionary Guard Corps (IRGC) stated in its Telegram channel that, in the event Iranian soil is bombed, it will target the cities of Dubai, United Arab Emirates, and Haifa, Israel, in the third wave of operations. So it could get very ugly, very quickly if a damaging cycle of escalation ensues, in which case we can expect haven bids to rocket. USDJPY and USDCHF will certainly extend losses along with gold and oil moving higher if the situation intensifies in such a serious manner.
However, if this attack proves a pin pointed strike with no US casualties and represents the full extent of the promised Iranian retaliation, then de-escalation will be the course of action. There are reports that warnings of inbound missiles were issued in time for troops to seek shelter in bunkers and move out of strike points. The US military would have been anticipating an attack in order to avenge the killing of Qassem Soleimani and if there are no US casualties, we can expect a far more measured and calm response from the US, with Iran’s actions seen as a necessary retaliatory escalation that simultaneously restores their credibility and de-escalates. US media in Tehran corroborates this sentiment saying, if there is no retaliation from the US then Iran will stop attacking.
Clearly at present, a myriad of uncertainties remain around a potential US counter strike and any further reprisals which will subdue risk appetite and could see volatility whipsaw markets again. Heightened geopolitical risk is also the exact opposite of recent market drivers into year-end, which were built on liquidity and a narrative of receding geopolitical risks, so there will be exaggerated headline risk at present. With valuations stretched and markets already expensive based on a lot of inbuilt positive assumptions, it doesn’t take much to tip the scales. And more broadly, the actions contribute a timely reminder to market participants of the persistent event risk that has weighed on global growth over the past 12-18 months and continues to support bond markets.
The lack of predictability from the tweeter in chief lends to fatter tail risks, so the range of outcomes are clearly quite frightening which will keep dip buyers hesitant, although those more sanguine may be ready to dive in and fade risk-off moves on reports of zero US casualties. President Trump’s decision not to address the US tonight and restraint on twitter is lending a glimmer of hope to traders that US responses will be more calculated and restrained.