The US dollar is surging against most of its major counterparts as Israel launches airstrikes on Iran, threatening to ignite a new war in the Middle East – still the origin of nearly a third of global oil production. With reports of explosions in Tehran crossing the wires, crude oil benchmarks are snapping higher as risk premia soar, Treasury yields are falling, and equity futures are bleeding.
The “pre-emptive strike” – to use the words of Israeli defence minister Israel Katz – has been widely rumoured for a few days, but its magnitude and key objectives remain unknown. Unconfirmed reports suggest that “dozens” of sites are under attack across Iran, and a spokesperson with the Israeli Defence Forces has suggested that the operation is expected to last several days, leading to the ultimate elimination of the “nuclear threat”. Given that many of Tehran’s facilities are in hardened underground bunkers, this would seem to indicate that ground forces are likely involved, but the scale of any incursion cannot be confirmed at this time.
Israel has closed its airspace in preparation for an expected retaliatory attack, with military experts anticipating a wave of drone and missile launches – similar to those executed last year, but perhaps wider in scale.
Iran’s strategic position on the Strait of Hormuz – coupled with its vast arsenal of small surface combatants and short-range missiles – gives it the capacity to strangle almost a third of seaborne crude oil transportation. Investors are watching warily for signs that the country could leverage that threat.
The currency market implications are difficult to parse.
As it stands, a wide-ranging flight to safety is underway, with the Japanese yen, Swiss franc, and US dollar seeing inflows as investors seek the deepest and most liquid financial markets available. Volatility could remain elevated for a while, with a “short squeeze” looming as a possibility, given that investors have piled into bets against the greenback in recent weeks. Conversely, risk-sensitive and emerging market currencies, particularly those of countries with close trade or energy exposure to the Middle East, are likely to come under selling pressure. The Israeli shekel could tumble as capital outflows increase, although we would expect central bank intervention to play an offsetting role. Traditionally oil-linked currencies like the Canadian dollar and Norwegian krone might enjoy some support if crude prices push past the $75-per-barrel level on a sustained basis.
These effects could fade quickly if Tehran keeps its “oil weapon” sheathed. But all bets are off if the conflict escalates or draws in other regional actors. The only historical templates we have are from the seventies and early eighties, and the world economy has changed significantly since then.