Markets on Edge as US-Iran Conflict Intensifies

On Saturday, US President Donald Trump and Israel’s Prime Minister Benjamin Netanyahu decided to add another painful page to this geopolitical saga.

President Trump accused Iran of failing to cooperate and gave the green light to the US armed forces to attack the country. The Israeli air force was also authorised to participate, targeting sites that would cripple Iran’s authoritarian regime and its ability to respond and defend itself.

The US President stressed that the combined US-Israel campaign would bring a regime change in Iran, adding that it would last as long as needed to achieve its goals. He also invited Iranian citizens to grab the unique opportunity offered to them, stand against the Iranian government and work toward a new future.

The attack on Iran is the sequel to last June’s airstrikes on several targets, including three nuclear sites. However, this time the US-Israel campaign appears set to be prolonged, potentially triggering more clashes in the region and destabilising the global economy.

Escalation: Middle East on Fire

The US and Israeli air force carried out strikes against various targets in the territory of Iran over the weekend, neutralising the country’s defences and hitting energy infrastructure related to its nuclear program. The Iranian armed forces retaliated against US camps and bases in the region as well as Israeli cities, using various types of missiles and drones.

For the first time, neighbouring countries in the region such as the UAE, Qatar, Kuwait, Oman, Saudi Arabia, Bahrain, Iraq got hit, with videos showing popular landmarks, such as the Burj Al Arab in Dubai, set ablaze by attacks. Drone strikes were also reported as far as Cyprus where the UK’s Akrotiri base runway was attacked, though without personnel casualties.

A joint statement from the US and six allied Gulf countries condemned Iran’s attacks as ‘indiscriminate and reckless’. In the meantime, the United Nations (UN) warned that potential hits on civil nuclear power stations could lead to mass evacuations of cities across the Middle East.

Ali Hamenei’s Death Triggers Succession Process

The first strike decapitated Iran’s leadership, killing Iran’s supreme leader Ayatollah Ali Hamenei, several members of his family, and a significant number of the country’s top military commanders when their hideout was bombed. Media sources indicated that the CIA provided the tip regarding the meeting, with Donald Trump and Benjamin Netanyahu deciding to seize the opportunity for the coup de grâce.

The leadership vacuum created by Hamenei’s death has left Iran in limbo. A temporary council, including President Masoud Pezeshkian and Ayatollah Alireza Arafi, who could be the country’s next supreme leader, has assumed control. Donald Trump’s call for new negotiations found closed doors as Iran’s security chief Ali Larijani said there were no plans to resume talks, accusing Trump for plunging the region into chaos.

Eyes on Hormuz Strait and Oil Production

As of writing, Iran has not officially confirmed a block on the Strait of Hormuz, one of the most important waterways in the world. However, Iran’s Revolutionary Guards appear to have warned tankers that they may not be allowed to pass through the route.

According to the UK Maritime Trade Operations Centre (UKMTO), two ships have already been struck by Iranian forces, while President Trump claimed that nine Iranian warships were destroyed as a result of military operations. A Reuters report noted that 150 tankers carrying Oil and liquefied natural gas (LNG) are stranded across the Persian Gulf.

More than 20% of the world’s Oil and gas production passes through the Strait of Hormuz. The strait was closed during the 1980’s Iran-Iraq war when the two countries aimed at each other’s ships (known as Tanker War), a clash that prompted international naval intervention.

On Saturday, the Organization of the Petroleum Exporting Countries (OPEC) and its allied countries decided to increase Oil production more than initially expected to offset potential shortfalls deriving from the conflict in Iran. Nevertheless, WTI Oil (West Texas Intermediate) and Brent Crude (UKOIL) prices got a boost amid persistent uncertainty and news regarding hits on Saudi Arabia’s Ras Tanura Oil refinery made the headlines.

Risk-off Market

Following an extremely fraught couple of days, the market opened with investors digesting the consequences of a war that nobody had quite expected to start over the weekend.

Oil prices gapped higher at the open – taking WTI Oil and Brent Crude higher by double digits – with Gold eyeing all-time highs. Airline Stocks are in freefall, and the Iranians have effectively closed the doors on the Strait of Hormuz.

Commodities Under Pressure: Energy Markets in Focus

Evidently, the most visceral response was from Oil prices at the open. Not surprisingly, financial media are attempting to clarify the impact of this conflict on Oil.

Brent and WTI opened higher by around 12% – the largest one-day spike in years. Undoubtedly, markets expected Oil to gap higher, but how high will Oil trade remains the question. Early European trading has witnessed traders pare back a portion of the opening gap, with WTI and Brent trading 8% higher at US$72.23 and US$78.85, respectively.

As we know, the Strait of Hormuz, through which roughly 15 million barrels per day of the world’s Oil flows, has all but ground to a halt. If this waterway remains closed for an extended period, the price of Oil will continue to climb, with some analysts already eyeing US$100. I read that there are capabilities to divert about 25% of the 15 million barrels through a pipeline to Saudi Arabia, but there will still be about a 75% shortfall.

From the charts, WTI demonstrates scope for further outperformance, targeting US$76.00, with any break of this base effectively clearing the runway to US$80.00.

Also outperforming are Gas prices. European gas futures are up by around 20%, with natural Gas futures up by around 3.3%. While Oil is catching most of the headlines, the fact that about 20% of global LNG transits the Strait has largely bolstered price action. Interestingly, I read that Goldman Sachs recently noted that a one-month closure to the Strait could fuel a 100% rally in European Spot Gas prices. Should this come to fruition, this would surpass that even seen in 2022 when Russia invaded Ukraine.

The Haven Trade

In addition to Spot Gold catching a rather solid bid and nearing all-time record highs of US$5,598, market participants have been shifting into the usual safe-haven instruments. Spot Silver rose 1.7%, and the USD has been rising as a hedge, bid against all other currencies right now. Of note, the buck has outperformed other typical safe-haven currencies, such as the JPY and the CHF, which both tend to attract demand in times of global turmoil.

In the Bond market, however, US Treasuries initially opened lower, but the move was really nothing to write home about, and, as of writing, yields are moderately rising across the curve. Could this be a case of investors moving funds out of Bonds into the USD?

I am wondering whether this subdued reaction in Bonds could have something to do with the fact that, if Oil prices continue to rise, this would impact inflation and prompt the Fed to remain on hold for longer than expected. I have seen a very moderate hawkish repricing in Fed fund futures, down from around 60 bps of cuts by year-end to 57 bps.

Stocks and Crypto

Equities offered limited refuge. Overnight in Asia, Japan’s Nikkei 225 dipped by 1.4% at the close of trading today, with the TOPIX shedding 1.0%.

In Europe, major Stock Indexes followed suit and are down across the board, and US Stock equity index futures are down around 1% for the S&P 500, Dow Jones, and the Nasdaq. As you would expect, Airline Stocks plunged in European markets as Middle East aviation largely remains grounded, while Defence and Energy Stocks are bid.

I have to admit; in terms of the Crypto space, I was expecting a more pronounced reaction in BTC than in other risk assets; we are actually seeing BTC modestly bid.

What is this telling us? Of late, BTC has been trading more like a leveraged high-beta risk asset. Its resilience this morning suggests a nascent ‘safe-haven’ bid. However, the modest nature of this rally compared to the aggressive flight into Gold and the USD indicates that BTC has not yet decoupled from risk assets. It remains in a state of transition, caught between its reputation as ‘digital gold’ and its reality as a leveraged liquidity play.

Written by FP Markets Chief Market Analyst Aaron Hill and Content Writer Miltiadis Skemperis