Global Macro: Limited fall-out for outlook so far – The recent escalation in US-Iran tensions and the rise in oil prices (see below) has dented investor sentiment, leading to a correction in equity prices on the one hand, and a rally in government bond prices, the yen and gold (see below), on the other. Market implied inflation expectations have risen hand-in-hand with oil prices, not only since the escalation, but since the start of last month. Although investors are starting to price in some risk that the situation gets much worse, the fall-out up until now has limited implications for the outlook for global growth and inflation. The changes we have seen in oil prices and financial conditions simply have not been significant enough to date. There might be an impact on business and/or consumer confidence over and above these effects, though that remains to seen. So overall, we stick to our current views on the global outlook, which is below consensus but for reasons unrelated to the US-Iran tensions, as explained in our previous Daily Insight note. (Nick Kounis)
Oil price outlook: Risks of future supply disruption – Brent oil prices touched USD 70/bbl on Monday as the tensions between Iran, Iraq and the US continued to escalate. These tensions follow the killing of Iranian General Soleimani by the US in Baghdad. Iran’s leaders have threatened to respond. Meanwhile, Iraq’s parliament voted to expel US troops from the country. US President Trump threatened Iraq with sanctions if US troops are forced to leave the country. Markets fear that a further escalation of the conflict may hurt oil production and/or -exports in the region. Up until now oil production has not been affected, and the higher oil price can be therefore for now be explained by the pricing in of a risk premium for possible future production disruption.
Middle East crucial for global oil supply – The reason that oil prices strongly react to these tensions is that a large part of global oil supply comes from this region. As can be seen in the table below, crude production in the region totals roughly 23 million barrels per day (mb/d). This accounts for 22% of global supply. The tension reminds investors of the last production disruption in September last year, when Saudi Arabia’s oil infrastructure was attacked by drones. Although never confirmed, many people assume that Iran was behind the attack. Another crucial risk is the Strait of Hormuz. This is a crucial transit point of oil and located between Iran and Oman. More than 17 mb/d of oil is transported via the Strait of Hormuz to a variety of destinations around the globe. On top of that, roughly one third of global LNG is passing the Strait of Hormuz on a daily basis as well. Any disruption to oil and LNG transportation, as often threatened by Iran, could result in large shortages and thus huge support for these commodity prices. Alternatively, US sanctions against Iraqi oil exports could be a big game changer. Iraq makes up 4% of global production and it would therefore take a serious bite out of available supply. Finally, direct military action, could potentially hit Iran’s crude production directly.
Oil price reaction most likely short lived – As long as these tensions do not result in actual production disruptions, we judge that the upward pressure on prices will prove to be short lived. The forward curve pictures a steep backwardation, suggesting that the stress of possible supply constraints are anticipated to have only an effect in the very near term. Due to the global production oversupply – even despite an OPEC production cut – and ample global inventories as well as strategic oil reserves, there will be no shortages of oil in the near term. Furthermore, investors already extended their long positions since early December and are already therefore positioning for further price gains. If the tensions do not escalate, we expect that the market reaction will be short lived and oil prices will ease in the course of the coming weeks. In the unlikely event of an escalation which actually does affect oil production and exports in the region, oil prices will continue its rally. The first important technical resistance levels are USD 72-75 and USD 80/bbl. (Hans van Cleef)
Gold price outlook: Strong rally in thin trade – Over recent weeks gold prices have rallied by a 100 USD to a new high of USD 1.588 per ounce. The move started just before Christmas. The support level of USD 1.450 per ounce on the downside proved to be a too hard nut to crack and investors became optimistic about the outlook for 2020 at a time when they became more pessimistic about the outlook for the US dollar. The rally received a strong boost from the tensions between the US and Iran. This morning investors came back from holidays and experienced a much higher gold price than when they left for holidays. Some may have bought it in a kind of panic this morning, while others who already hold gold will probably wait and see. The rally in gold prices has taken place in thin market conditions. The market will become more liquid in the coming days. If the move runs out of steam and/or the risk of a further escalation eases, some investors will probably take profit resulting in lower gold prices. This is because long gold is still a crowded trade. This is our base scenario. However, an escalation of tensions between the US and Iran could result in gold prices rallying above our year-end target of USD 1.600 per ounce (Georgette Boele).