• Geopolitical developments ring in the New Year

• Sustained rise in oil prices could snuff out nascent recovery

The first week of the year was relatively light on economic data, but not short on geopolitical developments. Financial markets started the New Year in an optimistic mood, boosted by news that the People’s Bank of China had cut its reserve ratio by 50bps. This move injects additional liquidity into China’s banking system in the hopes of supporting growth while also alleviating any potential funding stress for its banks heading into the Lunar New Year holiday.

Alas, this optimism did not last long. Markets were roiled on Friday and sentiments were rocked by abrupt escalation in Middle East tensions, after US military had killed Qasem Solemaini, the head of Iran’s Islamic Revolutionary Guard Corps — Quds Force. Risk aversion became the dominant theme, with deep selloff in global equity markets. Treasury yields took a dive while gold and oil prices surge.

The S&P 500 fell 0.7%, the Nasdaq composite slumped 0.8% and Dow Jones Industrial Average tumbled 0.8%. The US 10-year treasury yield fell by roughly 8bps as investors sought safer investments. Similarly, gold prices soared 1.5%. But the biggest impact of Soleimani’s death so far appeared to be on oil prices. WTI crude oil prices up 3.06% to USD63.05 whilst Brent jumped 1.3% to USD68.60.

Geopolitical developments ring in the New Year

There were two notable geopolitical developments that grasped markets attention last week. First, President Trump announced that the Phase 1 trade deal with China will be signed in the White House on January 15, which should provide its detailed terms. Second, and more prominent, Trump ordered an airstrike in Iraq that resulted in the killing of Qassem Soleimani, one of Iran’s top military generals. Oil prices jumped and Treasury yields fell on the news. The largest macro concern beyond yet more geopolitical uncertainty is the lasting impact to oil prices, which will depend on if/how Iran responds.

More than any macroeconomic data scheduled for this week, the tone of trading will be set by what Iran does next after the assassination of the head of the Iranian Revolutionary Guard’s last Friday. Iran has already threatened some form of retribution, leaving the questions of where and when unanswered. Predictions are complicated by the fact that instead of hitting back directly, Iran may choose an ally from a network that has built up in the region, for instance using sympathetic rebel groups as it did in the case of the attack on Saudi Arabia’s key refinery complex in September.

On the question of where, it seems to lean towards Iraq becoming the proxy battlefield for a conflict between Iran and the US with the former likely to try and hit US army points in the country. Alternatively, it may opt for a few vulnerable points in the Straits of Hormuz and the Arabian Peninsula. Iran may also choose to delay its response until it regroups after Soleimani’s death. The only thing that is certain is that Iran’s fury makes further clashes as good as inevitable, raising the geopolitical risk premium in oil.

Source: BIMB Securities Research - 6 Jan 2020