Oil spike grabs headlines, yet deeper risks are building in credit markets

The US and Israel initiated an attack on Iran on Saturday, 28th February.

It appeared to take investors by surprise, despite the fact that the US had pushed more military hardware (rather than troops) into the region since the second invasion of Iraq in 2003.

But it would be fair to say that most investors believed that talks between the US and Tehran over the latter’s nuclear ambitions had further to go.

Instead, there was a ‘pre-emptive strike’.

There were some sharp moves across financial markets on Sunday night.

The US dollar surged, suggesting that after a difficult year, the low may be in for the greenback.

Precious metals jumped and then reversed sharply, no doubt as investors panicked over the dollar move, and gave up on precious metals as any kind of ‘safe-haven’.

Oil blasted above long-term resistance, jumping 14% from Friday’s close to Tuesday’s high, thereby recording its highest levels since last June.

As a point of interest, the June spike came after Israel attacked Iran’s air defences and nuclear infrastructure.

Oil went on to hit a fresh high following the US bombardment of Iran’s nuclear sites just over a week later.

Oil then reversed direction, giving back most of its gains in a couple of days.

But back then, the Iranian response was tepid and performative, and the Strait of Hormuz remained open.

This time, Tehran acknowledges that the joint US-Israeli onslaught is existential for the regime, and consequently their response has been far more aggressive.

Iran has lashed out at its near-neighbours and has managed to block all commercial shipping through the Strait of Hormuz.

This has disrupted the passage of a significant proportion of crude oil and Liquefied Natural Gas (LNG).

President Trump has pledged US naval support and insurance for commercial ships passing through the Strait.

If this proves successful, then that would remove a chunk of risk premium currently in the oil price.

But what about equities? There had been a bit of a selloff ahead of the attack on Iran.

But that could be explained by the souring in sentiment as some of the froth was blown off the AI trade.

This was due to (deep breath) concerns over the size of the funds pledged to develop AI, the likely time it would take to see a return on investment, the undermining of businesses supplying software as a service, the possible effects on the services side of the economy in general, along with the prospect of a sharp rise in unemployment, particularly white collar, due to widespread AI adoption.

I’ve probably missed a few, but there’s the gist of it. This came as yet another company, linked to private credit, went out of business.

Market Financial Solutions (MFS) joined First Brands and Tricolor in being declared bankrupt amid allegations of risky or opaque financing practices, and possibly fraud or asset misrepresentation.

The three companies operated across different industries, and MFS was UK-based while the other two operated in the US.

But all were backed by private credit, and there have been suggestions that problems arose due to a lack of oversight.

Losses are being felt by hedge funds as well as major banks such as JP Morgan, Santander, Barclays and Jeffries.

And, there’s an underlying concern that there may be more bad news to come.

This is the real danger for risk markets now, not the attack on Iran.

Yes, there’s a danger that the war escalates. But one way or another, all wars end.

We’ve already seen a recovery across the major US stock indices, and Europe has followed.

But the likelihood of the S&P 500 taking out resistance, and its all-time high, around 7,000 has diminished somewhat, even as traders continue with that money-making ‘strategy’ of ‘buying the dip’.

Yes, it has worked extremely well since October 2022. But one day it won’t. Are we getting closer to that day?

(David Morrison is a Senior Market Analyst at Trade Nation. Views are his own.)