Markets reaction to US strike on Iran nuclear capability

Over the weekend, President Trump ordered the US military to carry out airstrikes on three of Iran’s key nuclear enrichment facilities — Fordow, Natanz and Isfahan — marking a stark departure from his longstanding anti-war posture. 

Under the guise of a two week window of negotiation, Trump claimed that Operation Midnight Hammer “completely obliterated” these facilities, and that the move was necessary to halt Iran’s potential nuclear weapon development, despite assessments from international watchdogs and U.S. intelligence that Iran had not yet committed to making a bomb. He warned Tehran that any retaliation would invite even harsher strikes.

Iran condemned the attacks as an “outrageous” with Iran’s foreign mister, Abbas Araghchi declaring that “Iran reserves all options to defend its sovereignty, interest, and people,” While there have been no immediate signs of radiation leaks, Iran’s leadership has vowed to defend the country by all means and may exit the Nuclear Non-Proliferation Treaty, which would further reduce transparency about its atomic activities.

What we are watching for

The reaction of Iran to this attack will dictate whether this is an isolated incident or another chapter in the tumultuous history of western powers and middle east relations. 

One key area of focus will be on the Strait of Hormuz, that runs between the Persian Gulf and the Gulf of Oman. About a fifth of the world’s oil runs through this narrow body of water, and so any disruption would cause a spike in oil price, which would impact consumer spending and fuel inflationary pressures. 

Its parliament has voted to block the Strait, but such a move would be unprecedented and cannot proceed without the approval of Supreme Leader Ayatollah Ali Khamenei. It should also be noted that Iran cannot legally block the strait under international law, so this would have to be achieved by force or threat of force. 

At this stage, it benefits lower-ranking Iranian officials to talk about closing the Strait of Hormuz, given Iran’s reliance on oil revenues. But actually doing so would be economically crippling. Over 90% of Iran’s oil exports go to China, a key ally, so a closure would hurt Iran more than the U.S. and risk straining ties with Beijing.

Further escalation could also come from the US or Israel targeting Iran’s strategically important oil exportation facilities at Kharg Island, which handles ninety percent of Iranian crude oil exports. This would be contrary to the stated aims of the current military action, which has focussed on nuclear proliferation.

Markets

The market reaction has been somewhat muted so far. 

Oil futures initially spiked to $81 a barrel but have since pulled back. While the market appears to be pricing in higher prices in the short term, the long-term outlook has not significantly changed, as reflected in the futures curve. The dollar also rose on the geopolitical instability, having been weak for much of the year.

In equity markets we have seen a modest softening with Asian equities down overnight, Europe opened down slightly while the FTSE 100 - reflecting the significance of the energy sector in the index - was up as oil majors such as BP and Shell were positive on the market open. During the course of the morning, markets have firmed up somewhat and are close to flat in sterling terms.  

Conclusion

The conclusion one can take now is that the market is pricing in ‘one and done’. The situation is still very dynamic though and what this period shows is the role and significance of geopolitics. 

Global uncertainty has been a feature of markets over the last year and whilst attention has turned from trade wars to military wars the result is the same: heightened volatility. However, history teaches that very often, geopolitical conflict often does not lead to protracted equity market weakness.

During these periods an investors best course of action is to look beyond the noise and assess the fundamentals of the market. This job – whilst potentially an uncomfortable experience - is made much easier if one’s portfolio is diversified and not positioned for a singular outcome.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

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