The Gulf and Global Markets

Summary: Thus far a modest market reaction and US President Donald Trump’s wish to avoid a major spike in oil prices as he gears up for his re-election campaign are signs that war is not the inevitable outcome of the Sulemaini assassination.

We are again grateful to Alastair Newton for the article below. He worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service.

“Iran has a strategic game plan on the ground in Iraq aimed at protecting and enhancing its influence in Iraq. The Americans do not.” Ranj Alaadin, Director of the Proxy Wars Initiative, Brookings Institution (quoted in The New York Times on 30 December 2019)

Our 3 January newsletter made reference to a quote widely attributed to the then British Prime Minister Harold Wilson at some point (Mr Wilson himself later claimed to be unsure of its original utterance) in the 1960s that a week is a long time in politics. One week ago exactly, I published my geopolitical Outlook for 2020 (available on request) which included a consideration of Saudi Arabia’s back channel outreach to Iran following US President Donald Trump’s tepid response to the 14 September attacks on Saudi Aramco. I went on to suggest that, for the time being at least, this “should reduce the risk of a conflict-driven spike in the price of oil — which should, in fact, suit Mr Trump who rightly recognises higher oil prices as a potential threat to his reelection prospects.”  In other words, the 21 December assessment of The Economist (subscriber access only) seemed at that time to be perfectly reasonable, ie that the two biggest uncertainties around the price of crude oil in the coming months stood to be the sustainability (or otherwise) of December’s tougher than expected Opec+ agreement on output and doubts over growth prospects in the US shale sector.

This assessment was also premised in part on the assumption that the so called ‘phase one’ trade deal between China and the US, now due to be signed in Washington on 15 January, would be ratified and would hold, thereby damping down concerns over what has been the biggest single issue for investors for the past two years or so including driving volatility in the oil market. Yet, less than one week later, ‘events’ in Iraq in particular have taken us to the point where it seems possible that Iran/US relations and their impact on the oil price could turn out to have more impact than China/US on the global economy in general and the price of oil in particular in the coming months. However, we simply can’t be sure one way or the other thanks to a combination of Mr Trump’s ever-mercurial nature and uncertainty over exactly how Tehran will retaliate, as it surely will, for the assassination of General Qassem Suleimani and what such retaliation will then trigger.

In such circumstances, Friday’s uptick of around 3.5% to just under USD70 per barrel (pb) in the price of Brent crude seems to me to be not so much a surge, as much of the press claimed, but a suitably measured reaction; and this remains the case even when one also takes into account this morning’s early-trading additional uptick which has pushed Brent to just over USD70pb. To put this in context, consider that in the immediate aftermath of the 14 September strikes the price of Brent crude rose by close to 20% to over USD70pb (albeit only briefly).

The critical difference is, of course, that on 14 September we had an event which impacted directly on oil supply, whereas, for the moment at least, it is, in my view, perfectly reasonable to see any negative impact on the flow of oil arising from the assassination of General Suleimani as no more than a tail risk. (And, as a number of fund managers remarked to me over the weekend, markets struggle to price in tail risks even in clearer circumstances than those with which we are currently confronted.)

In other words, a relatively modest market reaction of the type we have seen to date is probably justified until such time as we have a clearer idea of how and when Tehran is going to retaliate.

Thus, even though the Iranians’ 5 January announcement that they will no longer be bound by any of their commitments under the 2015 nuclear deal (on top of all the threatening rhetoric which has emanated from both Tehran and Washington over the weekend) does further increase political risk around oil in theory at least, there is presently no immediate reason to suppose that we shall see the current price level sustained, let alone a further uptick.

This being said — and potentially critically, in my opinion — the Iranians know full well that Mr Trump is (rightly) neuralgic about the impact which higher gasoline prices in the US would have on his re-election prospects. So, the temptation to try to hit back at him directly through actions which could see a sharp and sustained price rise cannot be ignored. Furthermore, there may well be influential voices in Tehran — especially among the hardliners there — which argue for just such an approach even now.

However, my personal sense is that the 3 November election is still too far in the future for this temptation to prove irresistible. Thus — and at the risk of being shown to be completely wrong, possibly even before the proverbial ink has dried on this newsletter — I presently lean towards Tehran’s biding its time over oil and looking to hit back at the US in other ways in the more immediate future.

Such an approach would, I believe, be entirely consistent with what many experts (e.g. Brookings’ Ranj Alaadin as quoted at the start of this newsletter) see as Tehran’s top priority, i.e. to protect the regional footprint which is very much General Suleimani’s legacy. Indeed, yesterday’s — admittedly non-binding — vote by the Iraqi parliament calling for US military withdrawal from Iraq is already a small moral victory in this respect to add to last week’s successful turning of protests in Baghdad, which had been essentially anti-Iran, into anti-America. (This was a smart — if, probably, opportunistic — move by Tehran. For sure, Mr Trump is no great shakes as a historian; but I am still certain it is not lost on him that the Tehran hostages siege was a significant factor in the defeat in 1980 of the last-but-one US president to fail to win a second term, Jimmy Carter.) It would be a surprise if, Mr Trump’s related threat of sanctioning Iraq notwithstanding, Tehran were not active behind the scenes encouraging the Iraqi government to pursue expulsion of the US military, which would also likely necessitate the withdrawal of what remains of US forces in Syria.

Iraqi MPs raise a picture of Qassem Sulemaini in parliament

Even though Mr Trump’s commitment to pulling US military personnel out of the region is popular with much of his electoral base, de facto forced withdrawal from Iraq driven by Tehran would likely be a blow to his reelection prospects, especially with white evangelicals who are strongly pro-Israel (and, therefore, anti-Iran) making up over one-third of that base. The President’s reaction in such circumstances is not easy to predict; but it may be to escalate (perhaps particularly under the influence of US Secretary of State Michael Pompeo who is an evangelical himself and a noted hardliner on Iran), including in a manner which does threaten to increase the risk to oil output in some way.

But it may not. Indeed, Mr Trump could easily flip again to the sort of “tepid response” which prevailed in 2019. Such a reversion may be particularly likely if former CIA officer and regional expert John Maguire is correct in his belief that the Iranians may not retaliate majorly for General Suleimani’s assassination immediately and that when they do it may be in a third country where US assets and personnel are not as strongly protected as they are in the Gulf region.

The same can possibly be said for the risk of an increase in Iranian cyber attacks on the US, which experts believe likely.

In short, and especially in that Brookings’ Mr Alaadin has rightly identified as the absence of “a strategic game plan” in Washington, Mr Trump’s off-the-cuff sense of what best serves his re-election prospects is very likely to prevail when it comes to determining how the US reacts to related action taken directly by, or attributable to, Tehran. And this may very well come down to his assessment of how best to keep the US economy more or less on track.

Which brings me to the stock market. Since he was first sworn into office, Mr Trump has consistently (if questionably) pointed to the performance of US stocks as a measure of his performance. But rising Iran/US tensions have triggered a slide in equity valuations worldwide which, together with the uptick in the price of gold, is consistent with a general increase in ‘risk off’ sentiment among investors.

This may or may not damage Mr. Trump’s reelection prospects (only a small proportion of his base benefits from higher equity valuations). But it is certainly not good news as far as Saudi Arabia’s Crown Prince Mohammed bin Salman is concerned; it has pushed Saudi Aramco’s valuation back down to the level of its stock market launch despite the higher oil price which MbS was probably craving to try to give some justification to his USD2tn valuation of the company. In the circumstances, I expect Riyadh to redouble its existing efforts to reach out to Tehran in order to discourage retaliation of any sort which could have an adverse impact on sentiment over Saudi Aramco. This, in turn, may reduce risk around shipping in the Strait of Hormuz, all other things being equal.

What all this amounts to, in a word, is ‘uncertainty’. And it is uncertainty which is compounded by the risk of a major miscalculation by one side or the other. But, for now at least, I am sticking to what is my base case for 2020, i.e. that, economically and financially, the year will probably unfold in much the same way as 2019 did simply because, as I wrote in my Outlook, “no-one has a bigger interest in keeping the economy on an even keel than US President Donald Trump as he seeks a second term on 3 November”. Nevertheless, the geopolitical risks to this relatively benign scenario are clear and, if anything, seemingly even more skewed to the downside than was the case just one week ago.

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