Markets cheer ceasefire, but risks linger over Hormuz flows and oil stability

Oil slumped, and risk assets surged late on Tuesday after news broke of a ceasefire between the US/Israeli coalition and Iran.

The announcement came less than two hours before President Trump’s deadline for Iran to reopen the Strait of Hormuz, or risk suffering an intense bombardment of its power plants and bridges.

Having threatened to kill off a ‘whole civilisation’ earlier in the day, this last minute deal, brokered by Pakistan, gave President Trump an opportunity to pull back from the brink.

He announced that Iran had put together a 10-point proposal which provided a basic framework for negotiations, and that he would cease hostilities for a fortnight to see if further progress could be made.

This ceasefire was contingent on Iran halting its attacks on shipping attempting to transit the Strait of Hormuz.

But what is unclear is if Tehran will now demand a toll for vessels passing through the Strait to ensure their safe passage. It appears that the Trump administration may be open to this idea.

The news led to some sharp moves across financial markets.

The most dramatic came from crude oil. Front-month Brent dropped to within a few cents of $90 per barrel, posting its lowest level in a month.

Front-month WTI experienced a near-20% drop from the overnight highs to overnight lows.

Both contracts managed to bounce a bit during Wednesday’s session, but remained comfortably below $100 per barrel.

This pullback contributed to a sharp rally across US Treasuries as yields fell.

This reflected a switch in interest rate expectations as the fall in the oil price was viewed as reducing upside pressure on inflation.

The CME’s FedWatch Tool saw the probability of a 25-basis point rate cut before year-end jump to 36% from 13% the previous day.

It’s worth bearing in mind that earlier in the month, investors had been busy pricing in the possibility of a rate hike this year.

The US dollar dropped sharply across the board, helping precious metals to rally.

The cash Dollar Index retested 98.50, an area of mild support, having started the week pushing up against resistance at 100.00.

The repeated failure to break and hold above 100.00 has started to raise questions about where the US dollar goes next.

While it has been very strong of late, and the ‘go to’ currency in times of market stress, it could be that the Dollar Index’s inability to push above 100.00 will bring out the bears.

If so, then there is a heightened risk that it pulls back and heads towards the lows hit in late January, under 96.00. It goes without saying that equities loved the news.

The S&P 500 briefly broke above 6,800 to hit its highest level in four weeks.

Bear in mind that a few days previously, it came close to hitting 6,300 to trade at an eight-month low.

News of the ceasefire has been welcomed generally. But no one really knows what it will mean in practice.

Two weeks is unlikely to be long enough to return shipping passing through the Strait of Hormuz to pre-war levels.

Also, there’s the factor of repairing the damage done to the energy infrastructure around the Gulf States.

It’s been taken as a ‘win’ for now, and that’s a relief. Markets have responded accordingly.

But now the hard work of building a sustainable peace must begin. And investors are now desperate for more good news to keep sentiment positive.

(This is a fortnightly column by David Morrison. He is a Senior Market Analyst at Trade Nation. Views are his own.)