US-Israel strikes Iran, markets react

In focus today

• In the US, the ISM manufacturing index for February will be released today. January's reading of 52.6 surprised to the upside, driven by a rise in new orders, indicating stronger final demand.
• The key focus today will be the unfolding of US-Iran conflict, following the US strike that killed Iran's Supreme Leader Ayatollah Khamenei and targeted key nuclear sites. Attention is on Iran's response and the risk of broader regional escalation, while markets react to rising oil prices and potential disruptions in the Strait of Hormuz.
• This week, key data releases include the February Flash HICP from the euro area and the UK spring budget, which will be presented on Tuesday. In the US, focus will be on a series of labour market reports, with the February jobs report, featuring NFP and unemployment figures, taking the spotlight on Friday.

Economic and market news

What happened during the weekend

The US and Israeli strikes on Iran, targeting the country's top leadership, missile program and navy assets, have plunged the Middle East into a regional war. Iran has retaliated by launching broad attacks across the Gulf. Domestically, Iran faces a significant upheaval, with a three-member provisional council taking control after Khamenei's death. The new Supreme leader is set to be appointed in the coming days. The tit-for-tat strikes are expected to continue at least for the coming days. Yesterday, President Trump signalled plans to engage with Iran's new leadership, despite also stating that the conflict could last up to four weeks. No timeline of talks has been provided, and Iran's security chief stated that negotiations with the US are not an option. Overnight, a significant development occurred as Hezbollah joined the conflict, leading to Israeli strikes on Lebanon.

Markets reacted sharply to escalating tensions in the Middle East, with equities under pressure and oil surged over 6% since Friday, boosting USD amid improved terms of trade. Safe-haven assets rallied, with gold up 1.6%, while CHF outperformed, pushing EUR/CHF near 0.90.

Energy markets, Brent crude surged sharply when markets opened, briefly touching USD 80 per barrel. The Strait of Hormuz (SOH), a critical chokepoint for app. 20% of global oil and LNG flows, has seen major shipping lines halt transits following Tehran's warnings and attacks against vessels. OPEC+ has announced a production increase of 206,000 bpd from April, but in the extreme scenario of a complete, weeks-long SOH closure, support to market would be insufficient. The likelihood of extreme action by Iran is undeniably higher than it has ever been, as the regime is battling for survival, but we still consider it unlikely that Iran could disrupt oil and gas flows for so long that it would trigger a global energy crisis.

What happened Friday

In the euro area, country-specific inflation data has been mixed. German inflation fell to 2.0% y/y (cons: 2.1%) from 2.1%, driven by sharply lower food inflation, while core inflation held steady at 2.5%. Services inflation regained momentum after January's VAT-related dip, confirming stable underlying dynamics. Spanish inflation surprised on the upside, with headline inflation at 2.3% y/y (cons: 2.2%) and core rising to 2.7% y/y. French flash inflation rose to 1.0% y/y (cons: 0.8%), largely due to energy base effects, though underlying inflation remains subdued. We forecast euro area headline inflation inching up to 1.8%, with core steady at 2.2%.

In the US, January PPI surprised to the upside, mainly driven by the volatile trade services category, reflecting higher sales margins by wholesalers rather than underlying cost pressures. Excluding trade services, producer prices were flat m/m, suggesting limited market impact.

In Norway, the seasonally adjusted unemployment rate (NAV) held steady at 2.1% in February, slightly below Norges Bank's 2.2% forecast. The number of unemployed fell by 1,000, while new vacancies declined slightly, underscoring a tight labour market, and enabling Norges Bank to focus on inflation when setting rates. Retail sales rose 1.1% m/m in January, with 3M/3M growth at 1.2%, indicating acceleration in recent months.

In Sweden, retail sales rose 0.1% m/m in January and 4.1% y/y, supported by strong durable goods sales, while consumables contributed negatively. Q4 GDP met expectations at 0.5% q/q and 2.1% y/y, driven by household and public consumption as well as investments. Negative contributions came from inventories and net exports.

Equities: Today, the focus is not on what happened last week or on Friday, but on developments over the weekend and into this morning following US and Israel's attack on Iran. Most Asian equity markets are trading lower, generally in a range of -0.5% to -2%. A few Middle Eastern markets are closed, and some smaller markets such as Karachi are down more sharply.

However, across the major markets, moves remain relatively limited given the scale of the geopolitical escalation. These are not outsized moves compared to what we could have seen on a major macro surprise.

The energy sector is outperforming this morning, as expected, but not to an extreme degree. Importantly, we are not seeing a pronounced defensive rotation. On a large macro shock, we would typically expect a much clearer shift into defensives than what we observe this morning.

European futures are currently down between 0.5% and 1.5%, while US futures are lower by around 1%. Again, in the context of normal daily volatility, this does not stand out dramatically. In itself, the equity market reaction - or relative lack thereof - tells an interesting story about how financial markets are currently assessing the situation in Iran.

FI and FX: The focus is on the market impact of the escalation of the war between Israel/US and Iran towards other parts of the Middle East. We have seen a rise in the oil price this morning as well as a strengthening of the USD, but modest safe haven flows in the bond market. Here, the initial reaction in JGB market has been a very modest with a decline of a few bp. US Treasuries rose rose 1-2bp in Tokyo trading hours. We expect to see some widening of the Schatz spread given the risk-off movement.