Drawing A Line Under Geopolitical Risk

WHERE WE STAND – Quite often, in this job, you get the feeling that you’re watching a film that you’ve already seen more than a few times in the past.

That definitely seemed to be the case yesterday, as markets rapidly moved past the weekend US strikes on Iran, had a brief wobble on news of Iran launching missiles towards US bases in Qatar, before steadying once more and shrugging off geopolitical risk, on reports that said attack had been successfully intercepted, while also having been very well-telegraphed in advance.

We can, hence, probably draw a line under geopolitical risk for now, and I’m content to say that those Iranian missile launches are indeed bullish for risk sentiment/equities, and bearish for crude going forward.

If that does indeed prove to be the extent of any Iranian retaliation to weekend events, then it is simply a face-saving and highly scripted exercise for the Iranian regime; one that allows some fairly impressive propaganda videos to be made, but one that has also done no real harm to the US bases that were targeted.

Furthermore, such an exercise also dramatically reduces the risk of further escalation, most notably when it comes to all the scaremongering around a closure, or other attempted blockage, of the Strait of Hormuz. That outcome was already unlikely, and I’d argue that yesterday’s events have reduced the probability of that occurring even further.

For the time being, the calculus remains that geopolitical events are likely to serve more as a short-term distraction for market participants, than they are any form of longer-run narrative. The Iranians have their propaganda video; the US have destroyed targets they’ve long sought out; and, market participants can relax that oil will continue to flow normally – everyone’s a winner! Once again, we see those who went ‘long hyperbole’ ending up with egg on their faces, while a calmer and more rational approach has borne fruit.

As a result, Monday proved to be a solid day on Wall Street, with stocks gaining ground across the board, having pared the opening gap lower by about 8am London time, and not really looking back from there. I remain bullish here, with fresh highs still on the cards, amid strong earnings and economic growth, and as the direction of travel remains towards a much calmer tone on trade.

On that note, the 9^th July ‘Liberation Day’ tariff pause expiry does seem to be creeping up on us, with just a fortnight to go until those chunky ‘reciprocal’ tariffs are due to come into effect. TACO is probably likely to apply here, mind, especially with the US having shown little desire, or ability, to stomach super-high tariffs on imports from key trading partners. The China trade truce is evidence of this point. While an extension of that pause seems likely, the whole saga feels like something markets have forgotten about. The ‘one, big, beautiful bill’ is another, actually, with the chances of that making its way to Trump’s desk by next Friday seemingly slim at best.

Anyway, I digress. Elsewhere, yesterday crude saw some substantial downside amid expectations for de-escalation in the Middle East, with benchmarks shedding over 7% apiece, paring an opening gap higher of as much as 6%. Back of the envelope maths says we still have a $10-ish bbl risk premium baked into front month pricing here, in a market that is fundamentally still over-supplied. It might require a bit of mettle, but short crude is looking increasingly attractive.

Treasuries, piggy-backing on the crude move, gained ground across the curve, not due to any kind of haven demand, but due primarily to lower inflation expectations. Were crude to continue barrelling lower, Treasury yields are likely to follow suit, especially as dip buyers fuelled by FOMO emerge once again, and amid anticipations that this week’s 2-, 5- and 7-year supply should be taken down well.

The FX space, though, it must be said, rather ignored geopolitical events, as participants instead focused on Fedspeak. While the dollar initially gained ground on weekend geopolitical developments, and energy importers such as the EUR and JPY faced headwinds, those moves rather rapidly reversed course after some dovish commentary from Fed Governor Bowman mid-afternoon. The Vice Chair for Supervision noted that, while in favour of a hold last week, she would be prepared to back a cut next month, if inflation remained subdued.

To be frank, the Fed – or certain policymakers, to be precise – are letting themselves down here. Last week, Governor Waller was touting the prospect of a July cut, upping the dovish ante in a blatant attempt to encourage President Trump to pick him for the Chair role, vacant next May. Then, Bowman, who was promoted to Vice Chair for Supervision by Trump earlier in the year, and has been an arch-hawk for the last 18 months, suddenly undergoes a damascene conversion to an uber-dove having got a bigger & better job. This is, bluntly, shameless from the pair of them, and certainly does nothing to help the Fed’s institutional credibility.

While my base case remains just one Fed cut this year, in December, this whole saga continues to support my overall bearish USD view. While Europe isn’t exactly a bastion of political stability right now, it does at least have monetary policy independence going for it, and still stands as a much more attractive option for international capital inflows.

This is also where gold comes in, as nonsense of the above ilk from certain FOMC members will only further encourage a diversification of FX reserves out of the USD.

LOOK AHEAD – A rather busy schedule ahead today, even if both geopolitical and trade headlines will steal most of the limelight.

Fed Chair Powell highlights proceedings, beginning two days of Humphrey-Hawkins testimony on Capitol Hill, though Powell is near-certain to stick to his ‘wait and see’ approach outlined in last week’s presser, and not endorse the July cut that Waller and Bowman are suddenly such huge fans of. Plenty of other central bank speakers are also due today, including five more FOMC members, and five from the BoE too, including Governor Bailey.

Elsewhere, the data docket is busy, albeit padded out with second-tier releases. This morning brings IFO sentiment figures from Germany, followed by Canadian CPI this lunchtime where, arguably, a cool print could see markets dovishly reprice the July BoC meeting, where a 25bp cut is currently seen as a 4-in-10 chance. Stateside, Richmond Fed manufacturing figures, and the Conference Board’s consumer confidence gauge are due, while this afternoon’s 2-year auction should proceed smoothly.