Markets Say "Could Be Worse" On News Of Hormuz Blockade

While it's clearly a risk-averse start to the trading week, amid President Trump’s announcement of a Navy blockade in the Strait of Hormuz, the general market reaction can be summed up as ‘could be worse’.

Markets Say "Could Be Worse"

Yes, crude benchmarks have jumped, with front Brent & WTI up around 8% apiece, and both having reclaimed the $100bbl mark. However, elsewhere, things are somewhat more contained. While equity futures do trade lower on both sides of the pond, spoos are down by less than 1% at the time of writing, while most bourses have pared a decent chunk of the opening gap lower. The same goes for Govvies, where selling pressure has been relatively muted all told; FX, where haven demand for the buck is hardly worth writing home about; and, metals, with gold facing little more than modest headwinds.

Explaining Away The Lack Of Reaction

While this (lack of) reaction could be considered perplexing, I'd argue there are a few reasons we can use to explain it away.

Firstly, Trump has already watered down the blockade. When initially announced, the move applied to ‘any and all’ vessels, whereas it has now been confirmed that the blockade applies only to ships heading to Iranian ports.

Secondly, during the blockade, the US Navy are to commence mine clearance operations, in turn paving the way to a swifter re-opening of the Strait once hostilities cease.

Thirdly, by choking off Iran’s primary source of revenue - crude exports - the market is viewing this as Trump trying to force Iran’s hand, and encourage a return to the negotiating table, after talks in Pakistan ended without a deal over the weekend.

Fourthly, despite the blockade, the fortnight-long ceasefire continues to hold, and the risk of massive escalation in terms of kinetic action - e.g. the destruction of Iranian power plants - seems to remain off the table for the time being.

Fifthly, Hormuz was essentially already impassable before Trump’s blockade was announced, meaning that the actual impact on crude supplies is likely relatively limited, to the tune of less than 2mln bpd (big number, yes, but not really when you already have 13mln bpd offline anyway).

Zooming Out

This brings me back to the two questions I've tried to focus on since the ceasefire was agreed. Are we moving towards peace? And, are we moving towards normalisation of flows through Hormuz?

Right now, I'd argue that we're not actively moving closer to either. Talks aimed at achieving a durable peace deal have broken down, and it remains unclear as to if, or when, they will restart. Plus, Hormuz is now effectively shut by two parties, the US Navy, and the IRGC.

However, I'd also argue that we're not actively moving away from either of those objectives being agreed. Viewing the blockade through the prism of a negotiating gambit increases the probability that further US-Iran negotiations will take place, while - as noted - present Navy operations could quicken the eventual opening of the Strait.

Against this backdrop, the market reaction as the new trading week gets underway is logical. We price out some of the ‘euphoria’ that swept the board last week, but at present there's little need to once more discount the potential for left tail risks to materialise.

With that in mind, I'd not be at all surprised to see risk assets remain underpinned to a degree, with continued hope that a deal can be agreed likely to continue to encourage dip buying, even as crude benchmarks are likely to grind steadily higher as physical supply tightens further.

The nub of the issue is this. Neither side seeks escalation, and both sides seek a deal to bring the conflict to an end. The journey to that deal will be a turbulent one, and shan't be a straight line. But, so long as we remain on that journey, the equity lows are likely in.