Markets Marching to the Beat of Oil Prices

The Middle East conflict between the US/Israel and Iran is now in its second week and continues to be the primary influence on global financial markets. Up to this point, the tendency has been for escalation rather than de-escalation, which in itself is a negative for risk assets. With shipping traffic through the Strait of Hormuz significantly reduced, oil infrastructure targeted around the Gulf region, and output adjustments by major energy players, oil prices have resembled a yo-yo this week. Crude has operated in a roughly 30% range, having spiked above $100 levels on Monday before pulling back, with traders reacting to the latest headlines around oil supplies.

Trump and the US have vowed to provide security and insurance for ships transiting the Strait of Hormuz, and G7 countries are deliberating access to strategic reserves. But as things stand, traffic remains disrupted, and Iran’s threats to interfere are causing stockpiles on land to rise and Gulf nations to cut further output with no clear route for exports. In other words, the oil market is highly unsettled, and extreme price swings are the result. In the near term, markets will likely continue to march to the beat of oil prices, with supply and inflation fears at the fore and an ongoing conflict that has no clear end in sight. $100 oil may well be the line in the sand separating relative risk-on and risk-off phases for global markets.

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In FX, the dollar has enjoyed a fairly good run since the conflict broke out, with the DXY hitting levels just above 99.60 earlier this week before easing back below 99 on profit-taking and crude pullback. The dollar has been the beneficiary of renewed questions over whether the Fed can deliver rate cuts this year if high oil prices persist and spike inflation. We don’t yet know how the oil story will play out or whether it will meaningfully raise inflation — the duration and scope of the conflict will have a big say. But the prospect of a prolonged period of high oil prices has helped the dollar thus far, with rate-cut expectations scaled back.

The dollar’s rise has stifled gold’s ability to shine during this period of heightened geopolitical instability and risk. Gold would usually prosper when conflict rages, but we haven’t seen it happen as yet. That’s because gold’s appreciation over the past year has been at least partially on the premise of US interest rate cuts occurring this year. But with high oil prices and inflation risks throwing doubt over when the Fed may be able to cut (if at all), scaled-back rate-cut expectations combined with the stronger dollar have effectively dented gold’s ability to surge. We did see gold make up some ground in the past 24 hours as the dollar took a step back, and any further weakness in the US currency could allow gold to capture more of the safe-haven demand it traditionally attracts during times like this. Technically, there is decent support for gold around $5080, with stubborn resistance awaiting around $5330.

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