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Markets Lick Wounds After Sharp Selloff

Markets are struggling to regain their footing after a rise in geopolitical tensions triggered a classic flight to safety. Equities and risk-sensitive currencies tumbled yesterday afternoon as investors sought refuge in bonds, the Japanese yen, Swiss franc, and dollar.

Benchmark crude prices jumped to the highest levels since October after Israeli Prime Minister Benjamin Netanyahu, speaking at a meeting of the security cabinet soon after a phone call with US President Joe Biden, said “Iran has been acting against us for years, directly and via proxies. And, therefore, Israel acts against Iran and its proxies, defensively and offensively… We will know how to defend ourselves, and we will act according to the simple principle: that those who harm us or plan to harm us, we will harm”. A wider conflict between Israel and Iran could threaten oil production throughout the Middle East – particularly around the Strait of Hormuz, a critical transit corridor for roughly a fifth of global supply. The ramifications would be exacerbated by Ukrainian drone strikes, which are believed to have affected more than 10 percent of Russia’s refinery output.

Iran seems likely to avoid broad escalation by launching limited reprisals against Israeli interests – and we’re generally inclined to fade the market implications of geopolitical shocks – but Brent is trading for more than $90 per barrel and West Texas Intermediate is holding above the $86 threshold as participants hedge themselves against a potential drive toward $100 amid ever-tighter physical market conditions. Calendar spreads are widening, with front-month prices rising much faster than for deliveries next year, pointing to a perceived shortage in deliverable supplies.

The Canadian dollar is sharply weaker, providing further confirmation of the change in trading dynamics that has taken place over the last few years. Elevated debt burdens have raised the sensitivity of the Canadian private sector to changes in global interest rates, changes in risk appetite are influencing cross-border capital flows, and the US has emerged as a net oil exporter. Historically, the exchange rate’s correlation with oil has tended to increase when prices have fallen below $30 or risen above $90 per barrel, but the threshold has likely moved higher after several years of elevated background inflation.

Interest rate implications have been limited thus far, but – given the role that gas prices play in setting consumer inflation expectations – the rise in global energy benchmarks could add greater weight to calls for a more cautious easing approach from central banks. The Federal Reserve’s March “dot plot” projections – which showed a median three rate cuts in 2024 – are looking increasingly vulnerable to change, especially given the chorus of officials expressing relatively hawkish outlooks on the underlying economy.

This morning’s non-farm payrolls report could be a market-mover. More evidence of strength in the US economy might lead some investors to double down on bets that the Fed will hold rates at elevated levels for longer, while an undershoot could see markets revising growth and yield expectations lower.

Market Retreat Continues as Yields Climb
Hawkish Kashkari Comments Pour Cold Water on Markets
Market Momentum Fades After US Long Weekend
No news is good news
Dollar Cruises Toward Weekly Gain on Fading Easing Expectations
Twists & turns

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