Asia wrap: Grappling with political risk

Recent political developments have created a sense of uncertainty in financial markets, particularly regarding the situation in the Middle East. Reports confirm that Israel has carried out an attack on Iran, which caused an explosion in Isfahan. The initial reports suggested that the explosion happened at a significant nuclear facility, which initially raised concerns in market circles. In turn, traders responded in classic reflexive risk-off fashion. However, the main question now is whether Iran will retaliate and how it will impact the Middle East political landscape.

Iranian state-controlled media appears to be downplaying the attacks, offering reassurances that nuclear facilities remain unaffected., making it potentially challenging for Iran's government to justify any retaliation if the narrative in Isfahan continues to be reported as a tempest in a teapot.

However, on a cautionary note, the air strikes could be interpreted as a test of Iranian air defence capabilities. And it’s probably wise not to completely rule out additional strikes on other specific high-value targets, mostly if Iran returns a volley in kind.

One possible explanation for the Iranian government's downplaying the attack could be their awareness of the potential for a more significant escalation. Given the current situation with Israel, which appears to be on a warpath with loud war drums beating, Iran may be seeking to de-escalate the situation.

The news has already impacted various asset classes, although the initial “risk off” wave in response has receded greatly.

After briefly surpassing $90 per barrel, Brent crude oil is currently trading sub $88 per barrel at the time of writing,

If we're using oil prices as a key barometer of Middle East risk, the current levels suggest that there's a perception of "nothing to see here." However, it could be far too early to signal an all-clear.

Safe-haven FX assets did experience increased demand, with the Swiss franc (CHF), Japanese yen (JPY), and the US dollar leading the pack. At the same time, currencies from the Antipodean region show the most significant underperformance.

The situation remains fluid, and traders will closely monitor any further geopolitical fallout from today's headlines to assess the risk of tensions between Iran and Israel escalating into a full-blown conflict in the region.