Geopolitics Trumps tariffs as main driver of markets

Geopolitics and the surge in the oil price are dominating markets on Friday. Brent and WTI crude oil  are higher by 7% and 6% respectively, after Israel launched airstrikes on Iran. Brent is now trading at $74 per barrel, earlier this week it was $66 per barrel. Iran is now planning to retaliate. Reports suggest that this is the biggest attack Iran has faced since the 1980s. Rumours have swirled all week that an attack was imminent, which is why the Brent crude oil  price is higher by 11% in past few days.

The sheer scale of the attack and the potential devastating consequences for the region is likely to support the oil price at elevated levels. Typically, geopolitical risks do not have a long-term impact on the oil price, however, this is a complex and evolving situation. Iran supplies the world with 5% of the global oil supply, so there is a risk that oil supply could be disrupted. This is why the oil price has surged, although it has pulled back from the 13% rise overnight. This conflict also has a nuclear element since Iran has the pulled out of nuclear talks with the US that were scheduled for Sunday.

No sign of nuclear escalation yet

The IAEA reported earlier on Friday that there has been no new increase in radiation from Iran’s nuclear sites, which suggests that a nuclear attack is not imminent. This is calming markets on Friday, and the oil price is pulling back. However, this situation could escalate very quickly.

On Thursday, the UN’s nuclear watchdog said that Iran was in breach of its non-proliferation agreements around nuclear weapons. Iran tends to respond badly to resolutions against it, and they said that will respond with a nuclear escalation. So far that has not happened, however, this is an evolving situation, and headline risk looms large for investors today.

The market reaction

These events are likely to weigh on risk sentiment today. European futures are lower this morning and the FTSE 100 is pointing to a 0.5% drop at the open. S&P 500 futures are pointing to a hefty loss, with the index expected to fall 80 points, and drop below the 6,000 level.

Although the oil price is facing headwinds, including the Opec supply increases and a subdued global economy, the options market suggests that traders remain bullish on the medium-term outlook for oil, particularly September call options with a $95 strike price for Brent crude. This is most likely some positioning in case the worst scenario arises, and oil prices hit $100 per barrel or more.

The gold price is rising this morning and is currently higher by $39 per ounce. The yellow metal is hurtling towards a new record high set earlier this month, when the gold price reached $3,431. If the escalation continues, or if a nuclear threat arises, this could trigger a surge in gold beyond $3.500, in our view.

A Dollar turnaround

The FX space is also reacting to events in the Middle East. The dollar has proven its credentials as a haven and is the strongest currency in the G10 FX space on Friday, followed by the yen and the Swissie. This is not a good day for risk, and the pound and the euro are both lower vs. the FX safe havens. Sovereign bonds are also rallying across the curve, and yields are lower, which once again highlights the Treasury market as a beacon for the financial world when risks emerge.

The situation between Iran and Israel is likely to dominate price action on Friday. Any escalation could be met by a wave of selling, and a surge in safe havens and commodities. However, if the situation does calm down then we could see oil prices retreat, even though we think there will now be a premium attached to the oil price for some time.  We also think that upside pressure in the US dollar will be temporary, and we believe that the dollar is likely to remain weak for the medium to long term, and today’s rally is a short term blip.

While risk is expected to sell off today, we think that defense stocks: utilities, defense contractors and some AI plays like Palantir, could be protected. If this conflict does escalate, if Iran does threaten nuclear strikes, it is another reason to speed up European rearmament.

Tariffs in the rear view mirror, as geopolitics take centre stage

Overall, tariffs and the US’s budget woes are going to play a secondary role to the geopolitical risks today. Investors also need to price in what higher oil prices mean for the future of interest rates. If the oil price continues to climb towards $100 in the coming days, then we could see the interest rate futures market price out rate cuts from the US and Europe, which may add to downside pressure on stocks. However, if there is no nuclear escalation, then we think we could see oil prices settle back around $70 per barrel.