There’s been an abrupt change in sentiment this morning, European stock markets are higher and oil and gas prices are moderating, after comments from Iran’s deputy minister about pre-conflict talks between Iran and the US. He said that Iran was ready to get rid of their uranium stockpile before the attacks from the US. The market is taking this as good news. Does it mean that Iran is willing to surrender their nuclear capabilities, and the war won’t be prolonged? These comments don’t actually change anything at this moment, but it does highlight how reactionary markets are to headlines right now.
Dollar remains haven of choice
Stocks across Europe are eking out small gains this morning, as the market mood shifts from one concerned about a prolonged conflict, to one that is hoping Iran and the US can reach a deal to end the fighting. European stocks have underperformed the US this week. The Eurostoxx 50 is down more than 5% on a currency adjusted basis, and the FTSE 100 is also lower by 3%. The losses have been magnified by a 1.5% decline in the euro and a 2.3% fall in the pound vs the USD so far this week. The dollar remains the haven of choice in the face of unprecedented conflict in the Middle East, and although stocks are back in positive territory today, the dollar remains higher as it may take more than a few headlines to dent demand for the liquidity and safety of the greenback.
Chart 1: The Dollar Index
Source: XTB and Bloomberg
US needs to signal an end to the war is close, for stock market rally to continue
This suggests to us that a prolonged recovery in stocks, and a drop in energy prices will need positive signals from the US. These have been lacking in the last 24 hours, after a hawkish speech from the US Secretary of War, who said that Iran is ‘toast’ and that Israel and the US will continue to bomb Iran. Thus, any positive sentiment may fade if the US contradicts any of Iran’s statements.
Bond market unmoved by Iran statements
US stock futures are still pointing to a lower open, which suggests that sentiment remains shaky. Added to this, the bond market has been unmoved by the latest headlines. Bonds are still selling off, and yields are higher across Europe. The depth of concern about an energy price spike on inflation in Europe is clear: UK 10-year Gilt yields are higher by 20bps this week, in France yields are higher by 15bps and Italian yields are higher by 17bps. German yields have had a moderate increase of 10bps, and US 10-year Treasury yields are higher by 11bps.
UK stocks more resilient to conflict than Gilts or pound
The moderate selloff in US bonds is helping to support the US stock market. Interestingly, the selloff in UK bonds is worse than the decline in UK stocks. This is down to the fact that UK stock indices are very international in focus, and the FTSE 100 and 250 both generate the bulk of their revenues outside of the UK. Instead, concerns about the potential for an inflation crisis in the UK on the back of an energy price spike is playing out in the bond market and in the UK interest rate futures market, which is now pricing in only 1 rate cut for this year. The pound is also taking a hit. GBP is the second worst performing currency in the G10 FX space so far this week, and concerns about the impact of this conflict on the UK economy is playing out in the pound. We do not think that we will see a meaningful recovery for sterling until there is safe passage for commodities through the Strait of Hormuz.
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