Trump’s plan for Strait of Hormuz fails to stop gains in oil price, as sell off takes a breather

Events in the Middle East remain in focus today as Iran prepares to bury the Ayatollah and announced its new supreme leader, Motjaba Khamenei, son of the former Ayatollah. There is still no sign of a deescalation of the conflict. Iran continues to bomb US targets in the region, and Israel has struck inside Tehran. An Iranian war ship is sinking off the coast of Sri Lanka, and there are reports that a Russian ship is also on fire.

Stocks in Asia sold off sharply, the Kospi in South Korea is down 12%. The Kospi has been the top performing index so far this year, even after these losses, it is still up 20% year to date.

The capitulation in European markets on Tuesday led to a massive shake out for global markets. The selling was indiscriminate and all sectors, including energy, came under intense downward pressure. Typically, capitulation sell offs do not last. Equity index futures are pointing to a mildly higher open for the FTSE 100 and other European indices today. There may be some mild optimism that President Trump’s plan to get oil flowing through the Strait of Hormuz could boost risk sentiment on Wednesday, although the risks remain to the downside.

There are signs that that the conflict may have financial repercussions for the region. Chinese investors are planning to scale back exposure to Middle Eastern debt, which is a blow to Saudi Arabia and the UAE. Although it is early days into this conflict, it may impact the ambitious economic plans for Saudi.  

The rise in energy prices continues today, although gains are milder than they were earlier this week. The Brent crude oil price is higher by 3% today and is back above $83 per barrel. The European Natural gas price is up another 20% and has risen 93% in the last 5 days. Although these gains are moderate compared to the spikes in  price we have seen in recent days, they suggest that there is some skepticism in the shipping market about President Trump’s plan for US warships to escort tankers through the Gulf of Hormuz and underwrite insurance.

The free flow of oil is essential to avoid a damaging energy price shock in the coming weeks. However, there is concern that President Trump’s plan is complex and cannot be executed as quickly as the market may like. This means that the risks remain to the upside for the oil price. Tuesday’s $85 high for Brent crude is a key level to watch, if the oil price breaks above this level, then it could open the door to $90 oil, which would be deeply uncomfortable for investors.

There are also growing supply concerns, Iraq has cut oil production, after some of its facilities were hit, and stress is mounting for energy suppliers across the region. While the US remains the world’s biggest energy producer, the Middle East is still a vital  part of the global energy mix due to the large number of major supplies. This suggests that risk to energy prices are still to the upside.

Until there is a pause in this conflict and free flowing oil around the world, it is hard to see how markets can stage a meaningful recovery. We expect stocks and bonds to remain nervous and driven by headline risk. Although futures markets are pointing to milder losses for most European indices, the risks remain to the downside.

The dollar has been king during this crisis, however, it is pulling back slightly today, and G10 currencies are clawing back some recent losses. This is likely to be temporary, especially if the oil price remains to the upside.