Middle East tensions are fading away like a pound of soap in a hard day's wash

Thirty minutes into yesterday's escalation left most proprietary traders scratching their heads by the lack of casualties and the absence of collateral damage. Not to mention the fact that none of the incoming missiles that were launched by Iran were intercepted by the US fortified missile defense system strategically integrated and reinforced to stop precisely this type of attack

But it was the lack of casualties that gave the markets more confidence that the Iranians had instigated little more than the intention to make a public show of force mainly to save face at home.

It seems tensions may have de-escalated now that Iran's retaliation (so far) turned out to be measured and caused no US casualties. Stocks came roaring back; treasuries fully retraced the overnight rally while gold positions had a virtual meltdown. That was until the serenity in the market was shattered early this morning on reports several rockets have hit the Green Zone in Baghdad, sending the algorithms back into overdrive. But frankly, unless Iran was crazy enough to launch these attacks at Iraqi civilians’ assets, especially after influential Iraqi Shi'ite cleric Moqtada al-Sadr called for the militias to stand down, the markets will likely quickly shrug this off as a lone wolf attack. Anti-American sentiment will continue to run thick along Iran's crescent of influence, so we should expect more of the same in the days and weeks ahead. 

For now, anyway, the US administration appears happy with the trade-off, as in their views cutting the head off the snake in exchange for some minor body blows makes good military sense. 

Reinforcing this view US President Donald Trump said on Wednesday, minimum damage was sustained from Iranian missile strikes and that Iran appears to be standing down. He sounded calm, relaxed, and collected in his White House address, which in turn removed any remnant defensiveness in the market seen earlier on Wednesday, as the critical risk sentiment indicator, USDJPY, started flashing green again and slicing through the significant 109 level. 

Hopefully, this will allow me to get back to what I like to do, analyze the market data for price discovery, and divorce myself from the armchair quarterbacking nonsense.

What did yesterday tell us? 

The brief risk-off spike showed the current safe haven go-to assets are yen, franc, gold, and Treasuries and that neither Iran nor the US seems to have the appetite for escalating the current situation into a major war. So, with President Trump delivering a benign Whitehouse address and in the absence of any further Iranian retaliation, this geopolitical fracas could fade away like a pound of soap in a hard day's wash.

Asia markets should have a healthy session with oil prices moving lower as it removes an immediate and significant risk to the local economies given their heavy reliance on oil imports

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Oil markets 

The sell-off in oil following an initial spike after yesterday's Iran retaliation should be a stark reminder that while it's wise to price at a higher level of geopolitical risk. It's going to take an actual disruption to the global oil supply chain to sustain a break above Brent $70 per barrel.

While President Trump's address placated concerns around Iran's fears, oil fell further after Suhail Al Mazrouei United Arab Emirates energy minister that OPEC is ready to respond to rising middle east tension. And that the cartel would seek to ensure that ample energy supplies are available.

Interestingly as more speculators are attracted to the oil markets, more barrels are also drawn to the tumult.

Still, oil prices should find support from the more pedestrian views around the trade deal, while the geopolitical risk premium should continue to underpin sentiment. Conditions remain ripe for a supply disruption from a terrorist attack given the anti-US attitude that continues to run thick along Iran's crescent of influence.

 

Gold markets

You could almost hear the algorithms laughing at gold shorts yesterday when the machines steamrolled over standing offers and triggering a wave of stop losses with it on the first Iranian escalation headlines.

But that rarified air above $1600/oz was always unsustainable as it was highly unlikely with the US self sufficient on oil, that yesterday's escalation would damage the outlook for the US economy and then pivot the Fed dovish. When it comes to gold's bullish ambitions in its purest pursuit, it always boils back to real yields.

Yesterday was an absolute recipe for disaster for the nouveau gold experts as gold prices virtually melted down on their trading screens. Unaware that Gold sensitivity to geopolitical risks was momentously higher than any other defensive assets and that surges in geopolitical risk can, by their nature, be short-lived and volatile, freshly minted longs were mercilessly hammered

Now that we've closed the gap from last Friday's close at $1552-53 oz, it should attract some buying interest around this level. But with focus likely to shift to the US economic data and the ultimate risk on trigger, the signing of the P1 trade deal on January 15, gold could struggle in this environment even more so if the global growth trade of 2020 picks up a head of steam. 

 

Currency markets

The Euro 

Volumes in G10 FX markets have been pretty light so far this year as a major theme has yet to emerge. The EURUSD continues to grind lower and has sliced through decent bids this week amid relatively small vol, and the stubbornly-bid dollar environment persists. No surprise really as the EU data continues to run wishy-washy while US data remains good

The Australian dollar and the Yuan 

If you were looking to get into the global growth for 2020 trade, it could be worth looking at the divergence in CNH and AUD as the Aussie has been hammered over the past four days on bushfires and Iran fears while the Yuan has remained firm. With the CNH likely to bounce after signing of the trade deal positively, the AUD shouldn't be that far behind, and the correlation could play some significant catch up in the days ahead. Even more so with risk on lights flashing green

The Malaysian Ringgit 

With regional risk sentiment improving and the US-China trade deal still on course to be signed January 15, despite softer oil prices, the Ringgit will likely coattail the Yuan positive skew into the P1 trade deal. 

Finally, the broader Asian currency markets can breathe again, with oil prices trading considerably lower.