UNCERTAINTY about how long the conflict in Iran could last is forcing investors to look to recent history as a guide for markets.
Many are revisiting trades enacted after Russia’s 2022 invasion of Ukraine, betting that this week’s spike in energy prices will stoke inflation, sparking lasting strength in the dollar as well as weakness in bonds and stocks.
While markets largely brushed off last year’s 12-day attack on Iran by the United States and Israel, investors are concerned this will run much longer.
“I can’t be any clearer, use the 2022 playbook,” said Jordan Rochester, head of fixed income, currencies and commodities strategy at Mizuho Bank in London.
“This is a logistics crisis as much as it is a war – a terms of trade shock with 20% of global energy supply unable to leave the region, even if temporarily.”
The unpredictability of war means sentiment could change rapidly, and some analysts said it’s too early to assume a shock on the scale of 2022.
A New York Times report Wednesday that Iranian officials had reached out to the CIA with an offer to talk gave stocks some relief and stalled the dollar rally. Oil pared gains.
Market reaction since the war started has clear echoes of the days following Russia’s attack on Ukraine. Brent crude has jumped above US$82 a barrel and natural gas soared to the highest level since 2023.
A global gauge of stocks is down 2% with South Korea’s Kospi suffering its biggest crash on record.
Treasuries have dropped as fears of inflation erode the Federal Reserve’s room to cut interest rates and the traditional safe-haven status of US debt. The dollar has strengthened against every major currency.
“Investors are starting to get nervous,” Bilal Hafeez, head of market strategy at Macro Hive Ltd, wrote in a report to clients on Tuesday.
“On Monday, they were expecting a short Middle East conflict, and US equities even ended up on the day. But today, markets are starting to price a more protracted conflict.”
That could mean oil rising to as much as US$100 within a month and the S&P 500 Index trading sideways or even dropping more than 10% if the 1990 Gulf War proves a template, he said.
If bonds behave as they have in previous conflicts, 10-year US yields could rise to between 4.25% and 4.6%, while the dollar could climb further against the euro and yen, he said.
Hedge fund manager Matthew Haupt at Wilson Asset Management is also turning to the Ukraine invasion four years ago for clues.
“We’re seeing pure liquidation – to an extent even safe havens are not safe,” said Haupt, who has closed bullish oil positions this week.
“The current playbook is similar to what we saw during Ukraine, but this time it’s about oil and it risks getting a lot bigger.”
The main source of concern in markets is that Middle East turmoil will transmit an inflation shock around the world, similar to that seen in 2022 when war in Ukraine choked supply chains and forced governments to spend to protect industry and consumers. Europen Union governments alone committed more than 500bil (US$582bil), financed by borrowing.
Back then, a broad gauge of the dollar’s strength rose 6% between Feb 24 and the end of the year.
Inflation worries sent yields on two-year Treasuries soaring by more than 2.8 percentage points in the same period, while those on 10-year paper advanced by 1.9 percentage points.
Gold fell and the S&P 500 posted a 19% loss for the year – its biggest decline since the 2008 financial crisis.
While European natural gas prices have surged as much as 85% since last Friday, they remain way below the peak hit in 2022. Still, the stakes for Europe could be higher this time as Russia’s energy remains out of bounds, and any incremental loss of supply could have an outsized inflationary impact.
Citigroup Inc strategists said a conflict that runs longer than two weeks could lift gas prices to 100 a megawatt-hour from around 55.
Yields in the UK and Europe have risen significantly this week as traders priced out rate cuts for the Bank of England and even started contemplating a rate hike by the European Central Bank.
Inflation concern
The repricing reflected concerns about inflation, and the potential for increased borrowing by governments already stretching to spend more on defense.
Higher oil and gas prices have dragged the euro below US$1.16 to its lowest since November. Options briefly echoed the stress, with one-week sentiment on the euro touching its most bearish level since 2022.
Howe Chung Wan, head of fixed income Asia at Principal Asset Management that oversees over US$590bil, is also looking at 2022 for an energy disruption playbook though he expects the Iran war risks will prove more significant.
“The impact of oil from Ukraine-Russia was mostly Europe, but this is broader,” said Howe, who has taken some profits on emerging-market bond trades.
While previous skirmishes had been contained mostly to Israel and Iran, “we might see a larger shift in the geopolitical landscape in the Middle East if Gulf Cooperation Council gets involved military wise”.
Risk sentiment
“The turn higher in risk sentiment after the New York Times report looks precarious given investors have plenty of reasons to be cautious. The report itself says that US officials are sceptical, and the outreach it mentions happened days ago. Such doubts are evident in the measured pullback in oil,” said Conor Cooper of Macro Squawk.
Also drawing parallels with 2022 was JPMorgan Chase & Co. While retail investors were patient with equities – avoiding selling for a month after the start of the Ukraine war – they were less patient with bonds, strategists including Nikolaos Panigirtzoglou wrote in a note.
“After a month, once it became apparent that the war would be protracted, inducing a more persistent oil price/inflation shock, retail investors started selling both equity and bond funds in a persistent way,” they said.
To be sure, not everyone is sounding the alarm. Deutsche Bank AG strategists note the rise in oil prices does not compare with some of history’s bigger crises, like 2022 and the Gulf War.
For recent energy shocks to lead to sustained declines of more than 15% in the S&P 500, investors have required oil to spike by at least 50% to 100% over several months, broader macro damage and hawkish responses from central bankers, the analysts said.
Focus on euro
“The scale of the current energy shock now versus 2022 is barely even comparable,” said Erik Nelson, a macro strategist at Wells Fargo. He’s telling clients to fade the kneejerk move and buy the euro, targeting a rally to above US$1.19.
Goldman Sachs Group Inc chairman David Solomon said it would take weeks to understand more about the situation, but that market reaction so far has been “benign.”
Still, many traders are wary. For four-decade markets veteran Rajeev De Mello, it pays to be cautious and the Ukraine invasion remains one of the best guides available to investors.
“Investors are forced to reduce portfolio risk, and so reduce equities and corporate credit,” said De Mello, global macro portfolio manager at Gama Asset Management SA, who’s cut some bets this week on European, Japan and emerging market equities.
“The lesson from 2022 is that investors should not immediately buy the first dip, because more is expected to come.” — Bloomberg
Ruth Carson, Abhishek Vishnoi and Olivia Levieux write for Bloomberg. The views expressed here are the writers’ own.
