By Michael O’Neill
Geopolitics reasserted itself into the financial market dialogue this week, and the world is a scarier place because of it.
US President Trump kept another campaign promise on Tuesday. With the stroke of his pen and a five-minute burst of hyperbole, he ended America’s participation in the Joint Comprehensive Plan of Action (JCPOA), otherwise known as the Iran nuclear deal.
JCPOA was a treaty signed by the United States, United Kingdom, China, Russia, France, Germany, and the European Union, agreeing to lift economic sanctions against Iran in turn for that country’s promise to limit uranium enrichment.
The President justified his actions by complaining that Iran does not like America and its “allies and partners,” and accusing the nation of being the “world’s leading sponsor of terrorism.” He said Iran fuels “sectarian violence in Iraq,” supports vicious civil wars in Yemen and Syria and commits grievous human rights abuses.”
He implied that Iran broke the treaty, citing sketchy evidence. It was reminiscent of then-Secretary of State Colin Powell, making America’s case for attacking Iraq for stock-piling weapons of mass destruction(WMD) none of which were ever found.
The European Union and the other signatories to JCPOA do not agree. They do not believe Iran has violated the agreement. Neither does the Director of the International Atomic Energy Agency, one of the institutions charged with monitoring Iran’s compliance. On May 8, Reuters quoted him saying “As of today, the IAEA can confirm that the nuclear-related commitments are being implemented by Iran.”
The EU High Representative for Foreign Affairs chided the President, pointing out that JCPOA was not a bilateral deal and said it wasn’t in the hands of any single country to terminate it unilaterally.
It is unlikely that France, UK Germany, China, Russia, and the European Union will follow President Trump’s lead. Will the US impose sanctions on these countries for continuing to trade with Iran and if they try, how will those nations respond? We certainly do live in “interesting times.”
President Trump’s decision had an immediate impact on the cost of oil. West Texas Intermediate (WTI) oil prices climbed steadily since April 6, in part because of rumours/reports that Trump would do what he did. Prices accelerated to $71.86/barrel, a level last seen in November 2014.
Oil traders are concerned that Trump has inflamed Middle East tensions. They have a point. Israel and Iran exchanged missiles in Syria on May 10. Fears that new sanctions will reduce crude supply at a time of rising global growth, shrinking crude inventories and on-going OPEC/Russia production cuts continue to underpin oil prices. If it continues, WTI prices could reach $88.20/barrel in coming weeks.
Geopolitical tensions may dominate the headlines, but their impact on FX markets evaporates faster than a cold beer on a hot day. The two main harbingers of risk-aversion are the Japanese yen and the Swiss Franc. Back in the day, flying missiles, soaring oil prices or the threat of Trade wars would have led to large-scale buying of those currency pairs. Not today. USDJPY has barely budged and is sitting comfortably above major support at 108.50. USDCHF rallied and is threatening to break above key resistance to extend gains to its 2016 peak.
Central bank policies are center-stage, and disappointment in their actions is driving FX direction. The Bank of England is the most recent poster-child for market disappointment. Governor Mark Carney and a series of soft economic reports knocked GBPUSD off a cliff, and it hasn’t found a bottom, yet. A few weeks ago, Mr Carney dropped a broad hint that UK rates would stay unchanged at the May 10th meeting which proved accurate. The Bank of England downgraded 2018 growth forecasts from 1.8% to 1.4%. Mr Carney is notorious for monetary policy flip-flops and today’s performance would give him a perfect 10 in Olympic Gymnast competition.
The US Federal Reserve is actively managing rate hike expectations. Atlanta Fed President Raphael Bostic and FOMC voting member said in a number of speeches recently that he is “comfortable” with an overshoot on the 2% inflation target. San Francisco Fed John Williams is another FOMC voting member not concerned with an inflation overshoot. The US dollar has powered higher in anticipation of further tightening of US monetary policy while other central banks leave policy unchanged. Many analysts are forecasting three more rate hikes in 2018, although the consensus is just for an additional two increases.
In the Eurozone, the European Central Bank was widely expected to announce plans for monetary policy normalization which led to a 1.2200-1.2500 trading range from the middle of January until the middle of April, this year. ECB President Mario Draghi has convinced markets of his determination to leave accommodative policies in place beyond the September end of the quantitative easing program. EURUSD crashed through support and has its sights set on the November 2017 low of 1.1540.
President Trump may have raised geopolitical tensions with his unilateral action with the Iran nuclear deal, but the true Merchants of Menace are the central bank heads and their mixed messages.