Why markets are ignoring the idea of a bigger conflict between the US and Iran, for now
- Stock futures plunged in overnight trading, but the market opened flattish and then moved higher after investors viewed Iran's response to the U.S. killing of Iranian General Qasem Soleimani as restrained.
- Stocks added to gains, oil plunged further and Treasury yields moved higher after midday comments from President Trump were viewed as "de-escalatory."
- The risk of Mideast disruption is less threatening now that the U.S. has become the world's largest oil producer.
- "I think the lesson from the last couple of years is it's quite dangerous to get trapped in these risk-aversion news cycles because they don't tend to last very long," said Jens Nordvig, CEO of Exante Data.
Global financial markets shrugged off U.S.-Iran tensions because they are not expected to escalate into a larger military conflict or seriously impact the global economy — at least for now.
U.S. stocks were sharply higher Wednesday and oil prices plunged, even though Iran attacked U.S. military bases in Iraq overnight. Stocks moved even higher later Wednesday, with the S&P 500 powering to a new all-time high and West Texas Intermediate oil futures breaking below $60 per barrel, after President Donald Trump defused some of the concerns by saying Iran "appears to be standing down" and that he doesn't want to have to use military force.
Stocks initially plummeted globally and oil shot higher right after Iran's missile strikes, shortly after the U.S. market close Tuesday.
The attacks largely resulted in infrastructure damage, and no human casualties were reported. Iran had warned Iraq about the assault ahead of time, and also announced the missile strike had "concluded proportionate measures" against the U.S., in retaliation for the American killing of Iranian Gen. Qasem Soleimani.
"I think the markets are more rational about this particular subject than a lot of subjects. ...There's not a lot of belief the Iranian leaders would want to do things that would seriously make this conflict a lot worse," said Don Townswick, director of equities strategies at Conning, which provides services for the insurance industry and other clients. "All that really does is give the administration the ability to treat Iranian leaders like they did Soleimani. I just think the market isn't worried about it. I also think the threat to the oil supply is not as dramatic as it was because of increased U.S. production."
Townswick said he is more concerned about fourth-quarter earnings results.
"It seems to be all about economics," Townswick said. "There doesn't seem to be a big threat to world growth. I think it comes back to the old saying, 'the markets overreacted to headline news.'"
Oil falls sharply
Overnight Tuesday as stocks sold off, West Texas Intermediate crude shot higher, reaching $65.65 per barrel, but it retraced those gains and was trading down 4.6% at $59.76 per barrel Wednesday. Brent crude futures reached $71.75 after the Iran attack, but were at $65.79 per barrel, down 3.79% Wednesday. Oil was also weighed down by U.S. inventory data, released midmorning, which showed a large buildup in gasoline supplies and other refined products.
U.S. oil production was at 12.9 million barrels a day in the last week, according to government data, and 3 million of those barrels were exported each day. The focus in the oil market has been on Iran's ability to disrupt oil supplies in two ways — by interfering with ships in the Strait of Hormuz, a key artery for oil transport from the Persian Gulf, or by hampering Iraq, Saudi Arabia, or any other producer's ability to produce and export oil.
"Not a single barrel of oil was lost or affected. As long as the oil supply doesn't get affected, the oil market rapidly removes the security risk from these events," said John Kilduff, partner with Again Capital. He noted that price spikes were quickly over after the attack on Saudi Aramco's Abqaiq facility in September and after the attack on Soleimani late last week.
"There's less of a chance of $100 oil because of it, and more of a chance of $75 oil because of supply and demand. That level of the oil price is perceived by everyone as a brake for the market," said Townswick. "A lot of people see $100 as the GDP slowing level around the world, and a lot of the estimates I've seen say if you disrupt some of the flow through the Straits of Hormuz you're going to see $75 oil, not $100 oil."
Jens Nordvig, CEO of Exante Data, said there was a minor flight-to-safety trade in the dollar but it was fleeting.
"We had it on Friday for 12 hours. There was a flight to the dollar and then we digested it and recovered into the close and had one hour of it last night and we're coming back," he said. "It definitely affected things last night, and the retaliation was a symbolic retaliation. It looks like it was meant for domestic political purposes, as opposed to inflicting any damage.
"There was a forewarning. That's not normal. It's obviously a serious issue but it really seems like a political symbolic move. It was a face-saving operation, and that's how the market is interpreting it."
Not a 'persistent driver'
Nordvig said the dollar index was higher Wednesday because the euro was lower on heavy bond issuance in Europe, but the dollar has been lower against the Chinese currency and other emerging market currencies on trade-related news.
"If we were going to have retaliation to the retaliation, there would be reprisal. ... That looks like it's not going to be the case," Nordvig said. "I don't think it's going to be a persistent driver of equities markets. It's different because shale oil provides a cushion. The oil market is not as sensitive as it used to be. I think the risk premium on the oil market will be somewhat higher but it's not like it's totally game changing."
He said hedge fund investors and others are less willing to position against major risk-off events.
"I think the lesson from the last couple of years is it's quite dangerous to get trapped in these risk-aversion news cycles because they don't tend to last very long," Nordvig said. "I think macro funds are reluctant to get too bearish."
In the bond market, strategists say investors were waiting for confirmation that the situation was not going to escalate, and the 10-year Treasury yield has already given back half of what it lost after the U.S. killed Soleimani. The 10-year had hit 1.94% on Thursday.
"The series of events led to a 24 basis point rally," said Jon Hill, senior strategist at BMO, adding the majority of that move reversed. "The data and the Fed and anything but the Iranian situation is pointing to higher rates in the near term."
He said Trump's comments were viewed as "de-escalatory," and the market will now focus on other factors.