We wrote on Friday that the US assassination of Iran’s ranking military commander had the potential to send shockwaves through markets and derail an expected period of calm. Well, events over the weekend have all but cemented that view: this is not a fleeting shift in sentiment. What we’re seeing is the beginning of a chain of events that will cause, at best, a massive strategic headache for European leaders, and at worst, a new war in the Middle-East.
Over the weekend, Tehran announced that Iran would no longer abide by any of the commitments made in the 2015 nuclear accord, leaving the agreement dead in all but name; Donald Trump threatened to attack 52 target sites in Iran if US assets in the region were targeted; and Iraq began a process to remove US military personnel from the country following US airstrikes on its soil, which prompted Trump to threaten sanctions. Overall, quite the escalation. The above has had a profound risk-off effect on markets, with the Yen at a three-month high against the US Dollar, a one-month high versus the Pound, and gold sitting at its strongest level in more than six years. Oil has also breached $70 a barrel on longer-term supply fears.
Strategically, Europe is now caught between a rock and a hard place, having seen its greatest foreign policy achievement – the nuclear accord – consigned to the scrapheap. Over the past several years, we’ve witnessed a steady deterioration in Europe’s relationship with the US over anaemic EU spending on defence, where the US has justifiably had to fill the gap. As a result, the bloc is powerless to alter the course of events or even to protect its own interests in the region, while Washington and Tehran act unilaterally in the weekend’s escalations. The US administration is channelling old ties and requesting support from EU states, but no one knows whether Trump has any actual strategy moving forward or if he’s just winging it.
In 2019, the Iran issue was on the back burner while global tensions focused on trade. Among the many problems currently in contention: Boeing versus Airbus on the topic of illegal subsidies; US warnings for auto and wine tariffs threatening the two largest economies in the EU; and criticism of the ECB rate policy as competitive devaluation. Now that security issues have re-entered the frame, given EU vulnerabilities there, the economic dispute might become even more complicated. The fear is that this issue sprawls further than it has in 2019 and leads to yet another year of geopolitical risks that impede business investment and delay economic spring.
Bottom line: We’re shaping up for a volatile week, resulting once again from geopolitical developments rather than any kind of economic data. Military retaliation from Iran is a very real possibility at this stage, in which case all bets are off. Until then, world leaders are left scratching their collective heads, wondering if there’s anything they can do to diffuse the situation.
The trade-weighted Sterling Index erased most of its New Year’s Eve gains on Thursday and Friday, closing the week at its 50-daily moving average. Boris Johnson returns from holiday this week and is expected to urge the European Union to open intense trade talks in the upcoming weeks. A light week ahead for UK economic data means headlines are likely to influence short-term Sterling sentiment.
Towards the end of last week, the US Dollar clawed back some of its end-of-year losses but opens this week slightly lower than Friday’s close. Rising US-Iran tensions could be the main driving force of the US Dollar this week, as severe retaliation rhetoric gets thrown around by both parties. While this geopolitical story could be the main driver for the Dollar for as long as the tensions continue, some key US economic data may provide short-term volatility during the first full trading week of 2020. Federal Open Markets Committee (FOMC) member Richard Clarida will be speaking on Thursday and may answer questions on the recent escalation between the US and Iran.
The Euro Index opens 2020’s first full trading week between the 50 and 100-daily moving averages which may provide support or resistance for the week ahead. The two levels lie just 0.22% apart, meaning one or the other could be tested soon. A break in either direction could set up the pair for a clearer course for the remainder of the week. Despite several Eurozone data releases this week, risk sentiment governed by rising US-Iran tensions may be the main driving force for the Euro - a flight to safe-haven assets could move the Euro lower.
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