US Strikes in Iran: Silent Escalation Challenges Deal Optimism and Raises Oil Risk

What happened

US officials confirmed attacks on Iran's Qeshm Island on Monday, validating earlier reports of explosions there. This incident is the latest in a series of limited strikes the United States has quietly carried out against Iran in recent weeks, without public announcement. Some officials described these actions as defensive, aimed at limiting Iran's ability to attack commercial shipping in the Strait of Hormuz. Qeshm Island, located at the mouth of the Strait of Hormuz, hosts a naval base, an underground missile site, and a desalination plant. Interestingly, these attacks occur while President Donald Trump publicly downplays the prospect of war, even stating that there had been no fighting with Iran for months and crediting falling oil prices to fading war fears. However, the Wall Street Journal reported that the US has told Gulf nations to prepare for a short, intense operation shortly after the midterm elections.

Why it matters

Confirmation of these strikes and the revelation of unannounced operations directly challenge the optimism that drove crude prices nearly 4% lower on Monday, based on expectations of a deal. The situation creates a two-way market for oil: on one hand, there's a risk of a sharp rebound if a broader military operation materializes; on the other, continued restraint and progress through mediators could support the lower price levels observed. Iran's threat to retaliate within and beyond the Middle East keeps tanker traffic through the Strait of Hormuz as a central risk, given the region's strategic importance for global oil supply. The discrepancy between Trump's public statements and the US's silent military actions adds a layer of uncertainty and complexity to risk assessment.

Market impact

• Interest rates and bonds: Elevated geopolitical risk perception tends to increase demand for safe-haven assets, such as US Treasuries. This could lead to a drop in their yields as investors seek protection against uncertainty. However, if the escalation leads to an oil supply shock and, consequently, inflationary pressures, yields could rise in anticipation of a more hawkish stance from central banks.
• Dollar and exchange rates: In times of increased global risk aversion, the US dollar tends to strengthen against other currencies, including the Brazilian real, acting as a safe haven. An escalation in the Middle East would reinforce this trend, putting pressure on emerging market currencies.
• Equities: Global equity markets tend to react negatively to increases in geopolitical tensions, especially those that could impact energy supply and the global economy. Uncertainty can lead to a broad sell-off of risk assets, affecting indices like the Ibovespa.
• Commodities: Oil is the most directly affected asset. The confirmation of strikes and the possibility of a broader operation increase the risk premium, tending to push oil prices higher. The threat to the Strait of Hormuz, through which a significant portion of the world's oil passes, is a critical factor for this appreciation. Other commodities may experience secondary impacts, depending on the extent of the escalation.
• Brazil: Brazil, as an oil importer and an emerging economy, could be doubly impacted. Rising oil prices could pressure domestic inflation and the trade balance, while global risk aversion could devalue the real and lead to capital outflows from the stock market and fixed income.

What to watch

Investors should closely monitor the following:

• Post-US midterm election developments: The materialization or not of the 'short, intense operation' mentioned in the report will be crucial.
• Iran's statements and actions: Any signs of retaliation or escalation from Iran, especially regarding the Strait of Hormuz.
• Official US communication: The consistency between public statements and military actions, as well as any updates on US strategy in the region.
• Diplomatic negotiations: Any progress or setbacks in mediation efforts that could lead to a deal or de-escalation.

Scenarios

Base Case: The strikes remain limited and do not escalate into a broader military operation. Optimism for a deal may re-emerge, and oil prices could stabilize or fall. Geopolitical risk remains elevated but contained. Risk Scenario: A broader military operation materializes after the midterm elections, or Iran carries out significant retaliations. This would lead to a sharp increase in oil prices, greater global risk aversion, and volatility in financial markets.

Original source: ForexLive (InvestingLive). For information only, not investment advice.