Nearly a week to the day when Iran sent drones and missiles into Israel, Israel has retaliated and sent a missile into Iran. The initial reports caused a large uptick in the oil price. Brent crude jumped nearly $4 per barrel on the news above $90 per barrel, but it has since retreated as the details about the extent of the attack emerge.

The missiles struck targets in Western Iran, and no nuclear sites have been damaged. Air space around Iran had been closed, but reports say it is now back open. Thus, we can assume this will not be a barrage of attacks and instead a one punch retaliation for Iran’s move last Saturday. As Jeremey Bowen of the BBC put it, the clandestine war between the two foes is now out in the open. So far, the attacks have been restrained, which is causing some relief to markets. However, the risk premium across asset prices is likely to rise as the future remains unclear. Will Iran and Israel leave each other alone now that they have had their tit-for-tat reprisals? Or does this continue, with well-planned ‘attacks’ that are designed to cause the least amount of civilian damage and are more a show of what could be possible?

While this is obviously preferable to an all-out war, it is a risky strategy. One mistake that causes casualties or hits an unexpected target could trigger an escalation in reprisals and a deeper, more dangerous situation in the Middle East. This is why volatility is likely to stick around, especially as it comes at a delicate time for financial markets as they recalibrate expectations for interest rate cuts.

Brent crude has now dropped back below $89 per barrel, but it is still $2 higher than it was on Thursday. The 10-year Treasury yield also fell sharply on the news of the missile attack on Iran. It fell to 4.49%, however, it has since climbed by 5 basis points and is back above 4.5% at 4.57%. The 2-year yield also fell back to 4.88% but is now making an ascent back towards the 5% level. German bunds also saw safe haven inflows early on Friday.

The increased Middle East tension also impacted the dollar. While the dollar spiked higher on a broad basis after the news was released, USD/JPY fell back from 154.60 to 153.60, as the yen received safe haven flows. Now that the situation seems contained, USD/JPY is climbing higher, although it is still lower on the day. The gold price is also higher and is up by $2 on Friday. It is currently trading at $2,381, which is just below the record high reached on Monday at $2,383, however, it had spiked as high as $2,417. This suggests that if we see a further escalation of attacks, then gold could easily break fresh records.

UK Retail Sales show consumer strain

GBP/USD is retreating on Friday; however, it is back above the $1.24 level. GBP has slipped slightly this week, but lower retail sales for March could make it harder for the pound to recover. Retail sales were weak last month, with the core rate of sales falling 0.3%, pushing the annual rate of core sales growth to just 0.4%. The headline rate of retail sales was flat. This highlights strains on the UK consumer, as well as signs that the bounce back in growth in Q1 growth, could be fading. With fewer rate cuts now priced in from the BOE, the prospect of a reprieve for the consumer looks in doubt.

UK retail sale volumes are basically unchanged, which suggest that UK consumers are paying more for fewer goods, which could keep the BOE wary about inflation. Department stores saw weak sales, and there were also falling food sales. Hardware and clothing were bright spots in this report. Overall, retail sales grew by 1.9% in Q1, which is not enough to boost overall Q1 GDP expectations, Q1 GDP is expected to have risen by 0.2%. This could limit the pound’s recovery on Friday.

Overall, the latest strike by Israel could increase the risk premium for stocks and other risky assets for the long term. US stock market futures are lower today, and European stocks may also struggle. This has been a bad week for risky assets. The S&P 500 is down more than 3% over the past 5 days, while the FTSE 100 has gained 1.7%, and is the top performer in Europe. However, on a currency adjusted basis the FTSE 100 is also lower by 0.6%. As the dollar rampages higher, this has a broad impact on financial markets.

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