Nuclear Overload

As things look to have cooled off within the Korean Peninsula, the nuclear problem looms its head in another area; this time Iran. The run up to the decision had numerous impacts upon markets, with the brunt of the volatility being felt in oil markets.

 

Following the lifting of sanctions in line with the Iranian-US-and-ally nuclear pact, the nation has come to be responsible for a daily oil production in excess of 4m barrels. The increase in production has seen Iran reliably produce an already globally systemic proportion of oil. Naturally, the tapering back of the deal and the reimposition of tariffs would cause the supply of oil from the nation to fall, projected to be in the order of several hundreds of thousands of barrels per day.

 

The impact for FX is confusing:

 

Firstly, it is important to remember that we exist in a new paradigm of oil: the United States of America is a net exporter of oil. Production in the world’s largest economy is therefore most likely to be internally reorientated, in and of itself generating a dampening effect to the medium run implication of a reduction in oil supply and the concomitant increase in its market clearing price. Nonetheless, even in the run up to the decision on Tuesday evening, oil prices rallied to reach as high at $70pbl. Following Trump’s threat to impose the ‘toughest sanctions’, Oil continued to rally through to approximately $77pbl.

 

There could well be a mild boost to domestic economic activity due to the idiosyncratic sectoral boost, however, the overall impression within the aggregate economy would be negative, generating a headwind that pervades across all sectors. Because the market for oil is truly global, the dampening effect is likely to be limited. However, if the rise in the costs of production and energy hampers President Trump’s prised headline economic indicator and success barometer of Gross Domestic Product, protectionist rules ensuring the provision of low cost oil to US companies are, for once, not at all out of the question.

 

The US, however, could be left in a tricky position from Trump’s decision to drop the deal: falling growth due to an economic headwind and rising inflation as the cost of factors of economic production rise could lead to a cursed situation know as stagflation, where an economic turn down is usually so pronounced that the fall in aggregate national utility and disposable income leads to severe political, and eventually civil, unrest.

 

Naturally, hostile domestic economic conditions and falling growth should indicate a weaker Dollar, as monetary loosening coincides with falling productivity and output. However, rising inflation would demand just the opposite unless the Federal reserve and government alike do the unthinkable and unwise, and abandon a target of price stability close to 2%.

 

A round of monetary tightening to constrain a rising price level could in turn lead to a stronger dollar should underlying economic growth and the domestic money supply, M1, remain resilient. Under this scenario, the Dollar should appreciate. However, sheer uncertainty and the threat of a stagnant economy with high price inflation should ensure a weaker dollar prevails.

 

The immediate move on Tuesday evening was a sell off in the dollar as concerns of upsetting the Fed’s current accelerating round of monetary tightening and economic growth developed. However, the countervailing forces were plain to see as, by European market open, the Dollar had once again gained strength and rallied by approximately 0.2%. Should more sympathetic conditions arise as natural stabilisers and economic resilience push through, the medium run trend of the US Dollar should be revised up.

 

 

Discussion and Analysis by Charles Porter

 

 

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