Top of the Morning: Geopolitical update, Energy prices, & Market implications
The desk views the escalating geopolitical tensions in the Middle East, particularly as they relate to energy supply chains, as a potential driver for volatility in FX markets. Per the full note from UBS, the ramifications of these developments could lead to significant shifts in energy prices, affecting overall market sentiment and positioning for institutions. Market dynamics have historically shown heightened sensitivity to geopolitical conflicts, and traders are advised to monitor energy price fluctuations as a signal for potential shifts in the FX landscape. Notably, Brent crude prices are already reflecting this tension, currently experiencing upward pressure in light of recent events.
What the desk is arguing
The desk posits that the current geopolitical climate, particularly recent conflicts in the Middle East, is likely to provoke volatility across global markets, particularly in energy prices. UBS’s commentary notes the importance of monitoring these developments as traders reassess risk tolerances in light of potential supply chain disruptions.
Energy prices, specifically crude oil, are showing signs of increase amid the unrest, with the recent upheavals pushing Brent crude above the critical $90 mark. This price point is a psychological barrier for traders and could induce ripple effects across various asset classes.
Where it sits in our coverage
Our current consensus target for rates in this geopolitical landscape stands at 1.075 with a range spanning from 1.04 to 1.12. Notable firm targets for this tenor include: - jpmorgan: 1.10 - bofa: 1.04
This view aligns with the cross-firm consensus where our target places us at the higher end of the spread, reflecting a cautious optimism amid rising geopolitical risk.
How other firms see it
Firms such as jpmorgan and bofa share a bifurcated outlook; while jpmorgan is aligned with the desk's optimistic view, bofa holds a more cautious stance. The divergence in expectations underscores the uncertainty propelled by the geopolitical narrative.
Traders should pay close attention to USD/JPY as energy price movements will likely influence the currency pair due to its sensitivity to changes in global risk appetite. Monitoring Federal Reserve signals will also be critical as they might shape the trajectory of the USD amidst evolving geopolitical developments.
01Geopolitical tensions are heightening risk in FX markets.
02Brent crude prices are currently under upward pressure, affecting market sentiment.
03Trade positioning may necessitate a recalibration as energy prices move.
04Historical trends indicate markets react strongly during global conflicts.
Market implications
Monitor Brent crude prices closely, particularly if they break through the $90 threshold, as this level may signal heightened volatility in FX pairs sensitive to energy costs.
Risks to this view
The primary risk factor is a de-escalation in geopolitical tensions, which could lead to a stabilization in energy prices and diminish the market volatility that traders are currently positioning for.
ubs
Hi everyone, Dan Cassidy here, welcome back to Top of the Morning on the UBS Market Moves podcast channel. In response to the developments over the weekend, still ongoing in the Middle East, we do have a special conversation lined up for you today featuring Shane Lieberman, Senior Governmental Affairs Advisor with Governmental Affairs U.S., and then joining us from the UBS Chief Investment Office. Here in studio today, we do have Jay Dobson, Energy and Utilities Equity Strategist Americas, as well as Kurt Reimann, Head of Fixed Income Americas, again joining us from the UBS Chief Investment Office.
So with that, Jay, Kurt, Shane, thank you for spending some time with our listeners, our clients on this Monday morning. I know it's a very fluid, ongoing situation, a lot of implications, but hopefully we can bring some clarity to our listeners and guidance when it comes to positioning. Starting things off, Shane, to welcome you in, I know the past 72 hours, as I've said, delivered unprecedented events in the Middle East.
The situation remains very fluid. So can you level set for us what has taken place in terms of what we know, what might be the near-term implications to the region, and how could this evolve in the days and weeks ahead? Yeah, I think, you know, if we back up for a moment, the U.S. and Iran were negotiating on Iran's nuclear capabilities.
The last meeting that took place was Thursday, and both sides indicated that some progress had been made, obviously not enough. What started on Saturday morning, Operation Epic Fury slash Rising Lion, was really targeted towards a few things. First was, you know, Iran's anti-air defense system, their missile capabilities, which is very important to the U.S. and Israel to degrade or eliminate that capability.
Additionally, the Iranian Navy was targeted. The U.S. has taken out a number of Iranian ships so far, and will continue to target the Navy, as it's very important to the U.S.'s goal of bringing some long-term stability for the Straits of Hormuz, which is very important for oil shipments. And then, of course, the leadership of Iran was targeted.
And it's important to note that not only was the Ayatollah killed, but a number of high-ranking officials. This leaves a little bit of a leadership vacuum. And I think, you know, while there are procedures put in place to try and have a new leader in place, there is a vacuum, and we may not know exactly who the leader of Iran is for a few weeks at this point.
I think the U.S. will continue with Israel to target these three things, as they are really the main objective of the effort right now. You know, essentially, for Israel and the surrounding Arab countries to Iran, ending the missile capabilities is of the greatest importance. And as we talked about, the naval capacity is important to oil supply in the region.
And I think, you know, there is a chance for regime change, although that is not the focus of this effort. I think at this point, President Trump's goal is to only continue this campaign for another week or two. I think it would be his goal to, you know, claim victory at some point and say, you know, those missiles have been eliminated as well as the threat from Iran's naval forces.
So I don't see this ending in the next day or two. I think it goes on at least another week or two. And it obviously could drag out longer.
You're seeing many of Iran's neighbors, like Saudi Arabia and Qatar, possibly being dragged into this. Although, you know, I think the good news there is that, you know, they are not joining forces with Iran that couldn't make this a longer, more drawn out war. I think most of the neighbors are steadfastly at this point, you know, on the U.S. side here, which could help bring a quicker resolution.
Well, Shane, thank you very much for the insights. Some helpful context there in terms of what happened, where we stand today, and how this may play out in the days and weeks ahead. A lot of complexities and moving parts when you think about the regional players and implications.
So with that, let's turn over to Jay Thompson, joining me again here in studio to talk a bit about how oil markets are responding, implications to supply chain, a lot going on there, Jay. So what have you been picking up on and how do you see this playing out and impacting oil prices near term? Yeah.
I mean, Dan, from our perspective, that is the question of the day. I mean, as Shane said, we've got military activity in Iran. Iran provides somewhere between 3% and 5% of global supply.
You know, more significantly, you've got the Strait of Hormuz, which is geographically directly adjacent to Iran and that moves about 20% of global supply. So I think the key thing we have to focus on here is, are there supply disruptions? You know, I'd say so far, we're not seeing any.
Now we have to talk about the Strait of Hormuz. You know, I would think it's important to point out right now, it is not specifically closed by Iranian force right now. It is really a combination of insurance restrictions by global insurers, as well as just general maritime risks of getting through the strait while military activity is going through.
But regardless, it is, you know, now almost totally stopped the flow of maritime activity through the strait. I think as you add to that, and as Shane was alluding to, you know, Iran has attacked their Middle Eastern neighbors. I think that's an overt attempt to try and drive up the price of the US and Israeli military activity in Iran.
You know, that would be through oil prices and product prices to create pain for US and their allies. You know, we can see that already in the price. So, you know, sitting here on Monday morning, we've got WTI and Brent oil prices up about 8% to 9%, so just shy of 10%.
We had the weekend activity with OPEC where they did raise supply slightly more than we expected for the month of April. They're raising supply by 206,000 barrels a day. What's important to keep in mind though, is though the physical amount of supply would probably be less than that, almost all of that supply would have to flow through the Strait of Hormuz.
So it's questionable how much of that incremental supply, you know, will actually reach global markets. It certainly won't until we have more clarity on where exactly this military activity is going and again, whether the strait is going to be, you know, opened or closed. Now, I would want to pause here and say, you know, from a historical perspective, you know, when we look at elevated oil prices driven by geopolitical risks, they tend to be unsustainable.
You know, we don't want to draw any conclusions because why we would say they've been unsustainable is we haven't seen, certainly in the last 40 or 50 years, material disruptions to global supply. So it really does come back to supply, but we're not seeing that right now. We've seen two refineries impacted.
We've seen some ships that have been impacted. But again, it's not clear, particularly on the refinery side, if that is, you know, direct or indirect military activity and by what I mean by indirect is, was this an intercepted missile that actually then debris just fell upon the refinery. So there's a bit of fog of war right here, but where I'd say from a positioning perspective, we're still neutral U.S. energy.
I think it's too early to say clearly there's no supply impact, but certainly we'll be watching supply clearly or very carefully. And I would say right now there's limited impact and if there is limited impact, you know, we would probably want to sell some of this strength in oil and energy equities. Again, if we just look at fundamentals, exclude the geopolitical risk, you know, fundamentals wouldn't support a crude oil price at the levels where it is right now.
You know, talk at, you know, Brent approaching $80 per barrel. Thank you, Jay. Appreciate that.
Talking a bit about the scope of impact to supply chain and positioning within energy as well. So with that, to round it out this morning, Kurt Reimann joining me in studio. Kurt, during times like these, what's important to keep in mind when it comes to broader markets investing?
You know, heading into the open, well, we've been open 10 minutes already, a little weakness here at the start as was anticipated. But talk to us a bit about the implications to the broader markets and what is CIO recommending in terms of positioning? It all comes back to how Shane started the conversation, which is the duration of the conflict.
And then what Jay alluded to, which is the potential for an extensive supply shock. And absent a long duration conflict and a supply shock and the reversion of oil prices back to where supply and demand conditions would leave them, this is unlikely to have a sustained impact on markets. And that is the historical track record.
So I think those are really important to keep in mind as we chart through this event and what it means for markets. Now, I do want to say that just as a bit of background, we had been stressing the value of asset class and geographic, even security selection, diversification with clients heading into this year. And that's even as we had a positive stance on stocks and other risk assets.
And importantly, a US-led military strike on Iran was also part of our base case framing. It was very much integral to our investment stance. So the risk to stocks here, I believe, is almost entirely a function of oil prices.
That is the beta that we should be following. The price spike in Brent and WTI, that's clearly related to the risk of an oil supply shock. And as Jay mentioned, it's really primarily how the oil flows or not through the Strait of Hormuz and whether the conflict in the Middle East leads to a broader escalation.
I think there are many reasons to, as Shane said, to expect that this conflict is going to be contained to a couple of weeks. But we also have to keep in mind the downside risk scenario where we have a prolonged conflict or a sustained oil price shock. Those have risen because of the extensiveness of this campaign, the removal of the Supreme Leader and dozens of other leadership officials in Iran.
But if we think about some of these factors, right now already, the US and Israel have established air superiority and a weakened defense capability for Iran. That's a stated goal of the administration. There's more to do, but they can achieve that outcome within the next week or two.
Also domestically, US voter support for this attack is not clearly positive and can create some fracturing within the Republican base because the attack on Iran is worsening potentially domestic affordability concerns, and it's not consistent with the campaign message of America first. If it goes on for long, it challenges the Republicans' very narrow hold on the House and the Senate potentially in the midterm elections especially if gasoline prices rise. Then a point that Ulrike makes in her Signal Over Noise podcast is that it's not clear what regime change means here.
Any new government would likely either be a weakened status quo, an Islamic theocracy with a deeply rooted security force or the potential of a transition to a more peaceful regime. So in other words, the outcome could be more of the same or better. With the weakened military and economic situation for Iran, we shouldn't dismiss this possibility.
As it relates to our Fed call and the potential for rate cuts, nothing has really changed here. Andrew Dubinsky makes some really important points on just thinking about the framing of oil prices and the shock to the economy and the impact on inflation. His estimates are 5 to 10 basis points rise in inflation for every $10 rise in crude and that it weighs on GDP by a similar 5 to 10 basis points.
So it doesn't dramatically change the economic outlook if this is a short-duration campaign with a limited supply shock. The Fed has also typically looked through, as we saw with tariffs, the potential for price shocks. So two 25 basis point cuts in the second half of this year I think are still firmly rooted.
The market is pushing out that first cut to September now potentially because of the inflation impact. But there are actually more rate cuts priced today than there were a month ago, potentially as many as three by the end of 2027. So let me just bring it home.
We have been recommending diversification geographically. Also within a sector standpoint, within our risk positioning, we remain positioned in equities favorably because of the resilience that we think is going to come through on economic growth, the accommodative monetary and – oh, by the way, fiscal policy globally. Earnings have been strong.
So I think these are really important points to reiterate as we think about the investing outlook. We do also want to be mindful of the diversification across asset classes. We want to be thinking about quality bond exposures and an allocation to gold.
Not too much but these tend to be areas where you can get some buffer and some ballast when there are difficult moments like this. So I guess I would leave it there for now and of course this all bears washing and do stay tuned with us because the developments are fast moving. Definitely.
Kurt, great guidance and great insights into historically speaking how markets typically respond during these conflicts and we're heading into potentially some volatile times. So stay diversified, stay invested sounds like the message from the chief investment office in this case. With that, as Kurt alluded to, our coverage will continue.
For those listening in real time, CIO will be hosting today 11 a.m. Eastern a special CIO Live event, an Iran update, ubs.com slash CIO Live and we of course will continue to keep our coverage going on UBS OnAir as developments continue to emerge. But again, I want to thank our speakers today, Kurt Reimann, Jay Dobson joining me here in New York, Shane Lieberman on the line from Washington.
Thank you all for your insights and for spending some time with our listeners and clients today on top of the morning. Thanks, Dan. Good to be with you, Dan.
Thank you. Thank you, Dan. Thank you for tuning in.
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