Iran conflict escalates further
NewsUpdate on ABN AMRO’s scenarios. Read their previous market comment.
The conflict in Iran intensified over the weekend, with no sign of de-escalation. Oil facilities were targeted, while Iran continued to strike Israel and several Gulf states despite earlier signalling it would halt these attacks. Iran ruled out an immediate ceasefire, and the appointment of Mojtaba Khamenei as the new leader indicates Tehran intends to continue to fight. Meanwhile, messages from the White House remain mixed, leaving markets uncertain about the likelihood of escalation or de-escalation.
In short, the situation remains fluid and unpredictable.
In this market comment we outline the response of financial markets, update our scenarios and discuss what this means for investors.
Markets sell off, then rebound
With the war escalating over the weekend, financial markets began pricing in a longer and more uncertain path to resolution. Early Monday offered few places to hide. Asian equity markets saw deep sell-offs, while the oil price (both Brent and WTI) briefly spiked to USD 119.50 a barrel, before retreating below USD 100 later in the day. European equities opened strongly in the red, but recovered during the day, closing with much smaller losses. The US remains the most defensive region since the outbreak of the war, recording the smallest losses. Bond markets initially sold off as yields rose, though they ended the day flat. Inflation concerns, however, pushed the markets to now price in one ECB rate hike this year and only a single Fed cut. Gold dropped, while the US dollar strengthened.
Oil’s sharp price rise reflected not only the expectation of a prolonged conflict and the damage to Iranian oil facilities but also concerns that Iran may retaliate by attacking oil facilities in neighbouring countries. On top of this, OPEC countries Iraq, Kuwait and the UAE cut back oil production due to limited storage capacity after oil tankers were blocked from passing through the Strait of Hormuz.
Updated scenarios
Last week we published our three scenarios for how the war could unfold. With the current developments, we have already had to adjust the probabilities assigned to each scenario, though the scenarios themselves remain unchanged.
ABN AMRO scenarios:
- Base case: The war continues ‘as is’ for the coming weeks before calming down, with an oil price at or above USD 100.
- Worst case: A prolonged conflict of three months or longer with an oil price at or above USD 130.
- Best case: Situation improves quickly with an oil price at USD 80.
Given the latest developments, a quick resolution appears unlikely for now. We therefore lower the probability of the best-case scenario from 25% to 10%. Our base case remains the most likely scenario, and we increase its probability from 50% to 60%. We also raise the worst-case scenario of a prolonged conflict to 30%.
What should investors do?
The situation remains fluid for investors. It is extremely difficult to assess how long the conflict will take. Even at moments like now where the situation appears to deteriorate rapidly, we should not forget that geopolitical trajectories can shift quickly, especially given the unpredictability of US President Trump. His comment to a reporter last night that the conflict ‘will end soon, but not this week’ is a perfect example of that.
From a technical perspective, equities are short-term oversold, while the VIX is overbought as is oil. A short-lived equity rally could reverse this without signalling the final low of the conflict. Oil’s break above USD 100 a barrel is psychologically damaging to the markets if it were to sustain for too long.
Our guidance remains unchanged: stick to your strategy. We believe it is best to stay put and look for opportunities once the conflict shows signs of de-escalation.
This market comment was provided by Ralph Wessels, Chief Investment Strategist from ABN AMRO.
You can find the original publication here.
