Middle East geopolitical escalation dents risk sentiment

Markets kick off the week on Monday on a tepid footing, as they take account of the weekend’s developments on the geopolitical front.

Geopolitical tensions between the West and the Middle East further escalated after the United States (US) and the United Kingdom (UK) conducted a new wave of air strikes on the Iran-backed Houthi militant group in Yemen on Saturday, hitting at least 30 targets.

The latest strikes come after Friday’s air assault aimed at other Iran-backed groups in Syria and Iraq, along with the Iranian Revolutionary Guard, seeking retribution for the drone strike that left three US service members dead in Jordan,” per the Associated Press.

In retaliation, Yemen’s Houthi rebels on Sunday vowed to extend their military operations and threatened to respond to the latest set of strikes by the US and the UK over the weekend.

Ameen Hayyan, a spokesman for the group, warned Sunday on X, the latest US and UK attacks “will not deter us from our moral, religious and humanitarian stance” in support of the Palestinians in the Gaza Strip.

The attacks “will not pass without response and punishment,” Hayyan added.

Amidst latest updates, US Central Command (USCENTCOM) confirmed on Monday that “on Feb. 4, at approximately 5:30 a.m. (Sanaa time), forces conducted a strike in self-defense against a Houthi a land attack cruise missile.”

“Beginning at 10:30 a.m. US forces struck four anti-ship cruise missiles, all of which were prepared to launch against ships in the Red Sea,” USCENTCOM said.

Market reaction

At the time of writing, the US Dollar is trading 0.14% higher on the day at 104.07 while the US S&P 500 futures, a risk barometer, are down 0.23% so far.

Risk sentiment FAQs

What do the terms"risk-on" and "risk-off" mean when referring to sentiment in financial markets?

In the world of financial jargon the two widely used terms “risk-on” and “risk off'' refer to the level of risk that investors are willing to stomach during the period referenced. In a “risk-on” market, investors are optimistic about the future and more willing to buy risky assets. In a “risk-off” market investors start to ‘play it safe’ because they are worried about the future, and therefore buy less risky assets that are more certain of bringing a return, even if it is relatively modest.

What are the key assets to track to understand risk sentiment dynamics?

Typically, during periods of “risk-on”, stock markets will rise, most commodities – except Gold – will also gain in value, since they benefit from a positive growth outlook. The currencies of nations that are heavy commodity exporters strengthen because of increased demand, and Cryptocurrencies rise. In a “risk-off” market, Bonds go up – especially major government Bonds – Gold shines, and safe-haven currencies such as the Japanese Yen, Swiss Franc and US Dollar all benefit.

Which currencies strengthen when sentiment is "risk-on"?

The Australian Dollar (AUD), the Canadian Dollar (CAD), the New Zealand Dollar (NZD) and minor FX like the Ruble (RUB) and the South African Rand (ZAR), all tend to rise in markets that are “risk-on”. This is because the economies of these currencies are heavily reliant on commodity exports for growth, and commodities tend to rise in price during risk-on periods. This is because investors foresee greater demand for raw materials in the future due to heightened economic activity.

Which currencies strengthen when sentiment is "risk-off"?

The major currencies that tend to rise during periods of “risk-off” are the US Dollar (USD), the Japanese Yen (JPY) and the Swiss Franc (CHF). The US Dollar, because it is the world’s reserve currency, and because in times of crisis investors buy US government debt, which is seen as safe because the largest economy in the world is unlikely to default. The Yen, from increased demand for Japanese government bonds, because a high proportion are held by domestic investors who are unlikely to dump them – even in a crisis. The Swiss Franc, because strict Swiss banking laws offer investors enhanced capital protection.

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