Since the drone strike in Baghdad that killed Iranian Major General Qasem Soleimani last week, markets have reacted with a flight towards defensive assets and classic hedging trades against middle eastern tensions. The winning candidate at yesterday morning’s open was oil, with Brent Crude up as much as seven percent in yesterday morning’s early European trade. The West Texas Intermediate benchmark has also risen by as much a six percent since the strike. Given the systemic importance of the region to the global oil supply, long oil positions are a good hedge to rising middle eastern/gulf tensions because intensifications in such circumstances create fears of instability in the provision of the world’s oil rising expectations of scarcity and therefore its price.
In second place was Gold. Similarly denominated in US Dollars, the ultimate safehaven has picked up as much as 3.5% in value rising to a level not seen since 2013. 2019 was dominated by trade tensions particularly between the US and China which even during its fever pitch was unable to push the price of an Ounce of Gold above the $1550 level. The appeal of gold can be strongly linked to the price of oil. Inflation is seen as a by product of the price inelasticity of oil and gold is a quintessential hedge against inflation given the perception of its intrinsic rather than derived value.
Throughout last year we spoke a lot of the defensive appeal of the US Dollar. This has not disappeared and the Dollar will not be shunned during investors’ flight to safety. However, the even safer form of US money, US Treasury bills, have been preferred havens instead of simply holding the fiat currency itself. The preferred investment has been at the long dated end of the United States’ fixed income offerings. Accordingly, the yield curve in the US has begun to flatten once again. Invoking signals of recession and yield curve inversion for the first time this year but the umpteenth time in twelve months, bond market price action was seen to undermine the Dollar’s spot value. To compound this risk to the greenback it is worth noting that the US Treasury will auction off $156bn in debt this week and demand conditions in the primary market are known to have a significant spill over into the foreign exchange market.
There are still classic FX plays to the US-Iran headache at foot. The Japanese Yen, a primary barometer of risk has outperformed its peers rising about 0.4% across the board. In tow close behind is the Swiss Franc which has seen increased demand since the drone strike was ordered by President Trump on the night of Thursday 2nd January. To fund these defensive trades holdings of riskier currencies, including but not limited to the emerging market basket of currencies, were sold. With an extreme risk profile looming over it, the South African Rand has been one of the worst affected currencies in the defensive asset reallocation activities spurred by this recent geopolitical headache. With a consolidation in repositioning during yesterday afternoon’s late European trading session, the Rand picked back up a few conciliatory cents from its morning sell off.
Until yesterday, the Pound had also been eschewed in favour of more concrete havens. Yesterday reversed this Sterling sell off kick started by UK soft data worthy of market optimism. First off a revision of December’s Services PMIs from contractionary territory gave traders an excuse to price out some of the pessimism created around the data’s initial release. Next up, we learned that new orders data accelerated month-on-month at the fastest pace in six months. Simultaneously, a popular business confidence barometer hit a 15-month high alongside a minute uptick in employment figures. The conclusion was that the general election has provided a degree of confidence and commitment in business as political risk was seen to unwind. Sterling gained and has largely held onto a 0.86% rally versus the US Dollar.
Discussion and Analysis by Charles Porter