Global equity markets fell sharply on Friday (US time) in the wake of escalating tensions between Israel and Iran and will likely fall further in the coming days following Iran’s decision yesterday to launch an unprecedented missile attack on Israel.
Growing concerns of a potential new regional conflict in the Middle East saw the price of Brent crude oil spike briefly above US$92 a barrel, with the potential for prices to surge back above US$100 if the conflict was to escalate into a full-scale military offensive.
Further unnerving investors, last week saw the US dollar stage its strongest weekly performance since 2022 after higher than expected US inflation figures caused serious ripples through global financial markets.
The US dollar index ended the week up 1.7 percent against a basket of currencies as traders reversed bets on early interest rate cuts by the Federal Reserve pushing the NZ dollar down to a five-month low of 59.37 US cents.
A sharp increase in US consumer price inflation — which hit a higher than expected 3.5 percent for March — has prompted traders to increase bets that the Fed may only deliver as few as one rate cut this year. That compares with expectations of as many as six quarter-point cuts at the start of January. Ominously, some Fed officials have also not ruled out the possibility of a further rate hike if the data continues to remain above forecasts.
And on Thursday, the European Central Bank signalled it remained on course to deliver interest rate cuts in June. Pressure on the euro increased because of growing expectations that eurozone interest rates will fall ahead of those in the US. The single currency fell 1.8 percent for the week, its biggest weekly decline since September 2022.
Fears of an impending attack by Iran on Israel, in response to an air strike on the Islamic Republic’s consulate in Syria, is likely to have contributed to the dollar’s strong recent run, according to analysts. The dollar is considered a haven asset for investors during times of heightened geopolitical uncertainty.
However, sustained US dollar strength could cause problems for central banks, including the RBNZ, looking to cut rates without undermining their currencies and accelerating price rises.
“Other central banks clearly don’t want their currencies to weaken materially . . . what it means is effectively you will end up importing more inflation” James Novotny, a portfolio manager at Jupiter Asset Management told the Financial Times.
Japan’s currency too remains under significant pressure from the rise in US rate expectations, which has pushed the yen to its weakest level since 1990, putting its finance ministry on high alert for a possible intervention. Masato Kanda, Japan’s vice-minister for finance for international affairs, said that authorities would “not rule out” any measures to address excessive moves in the exchange rate.
As Bloomberg columnist John Authers pointed out recently, the expectation for multiple interest rate cuts which have underpinned equity markets this year, particularly in the US, are increasingly looking much less certain as economic data continues to surprise on the upside.
“The fact that investors are still pricing in policy easing in the US remains a huge deal. For now, the contrarians who see no cuts this year, or even hikes, are in the minority,” Authers said.
“But they will certainly win over new converts if the recent trajectory of economic data continues even a month or two further. That could be contagious; other currencies are already catching a cold from this US sneeze. It’s not pleasant to think about what could happen if US rate-cut hopes were abandoned altogether.”
A worrying scenario investors are increasingly having to contemplate could be a real possibility, not to mention how markets would react to the prospect of further rate hikes.
NZ sharemarket left wrong-footed after global markets weaken
The NZ sharemarket is expected to fall sharply when it opens today after reversing an earlier 100-point sell-off on Friday that has left it ‘wrong-footed’ in the wake of escalating hostilities between Iran and Israel occurring after the local market had closed.
News of a potential retaliatory strike by Iran on Israel saw the benchmark S&P500 index in the US slide 1.5 percent on Friday, its biggest one-day fall since late January, while a weaker than expected quarterly earnings result from US banking giant JP Morgan, which saw its shares fall six percent, only further soured investor’s mood.
Confirmation on Sunday (NZ time) that Iran had in fact launched direct missile strikes on Israel will only further unnerve markets.
The price of Brent crude oil ended the week down slightly at US$90.15 a barrel after earlier spiking above US$92 on Friday in the wake of escalating Middle East tensions, while also pushing above its 100-day weekly moving average, a traditionally bullish indicator.
Locally, this Wednesday’s consumers price index print for the March quarter will also have investors on edge.
Kiwibank chief economist Jarrod Kerr is expecting consumer prices to have risen 0.8 percent over the quarter, an acceleration from the 0.5 percent lift at the end of 2023.
“Annually, we see inflation decelerating to 4.2 percent from 4.7 percent – the lowest since June 2021, though the RBNZ’s February forecasts are more optimistic. They expect a 0.3 percent rise in the quarter, and the annual rate falling to 3.8 percent.”
While Kerr says a downside surprise would be a great outcome, be believes imported inflation will likely turn out to be stronger than what the RBNZ expected back in February.
“And that reduces the likelihood of the headline rate falling below 4 percent. Inflation will continue to fall from here, but risks to the RBNZ’s forecasts are tilted to the upside, in turn delaying the start-date for rate cuts.”
Kerr expects bets for cuts as early as August being pared back and pricing pushed out should the official number print above the RBNZ’s 3.8 percent, while the Kiwi dollar will likely also receive a boost following an upside surprise after falling to a five-month low on Friday.
Not wishing to be sceptical yet…the idea of full-scale ‘war’ between Iran and Isreal is so laughable that it is embarrassing that global media is reporting it so positively [bravo NZ media for not covering]. It’s as laughable as the ‘Russia may attack NATO countries’ narrative. Remember the Middle East rejoices, especially countries like Iran, if oil prices rise. The losers are countries like NZ who have high inflation and were stupid enough to ban oil/gas and close our refinery. No interest rate drops for us this year.
Countering the imported inflation via a weaker $NZ is the increased $NZ returns to exporters.