Dollar as `Wrecking Ball' May Blot Out Iran's Market Impact

(Bloomberg) -- For all the diplomatic furor the U.S. created when it walked away from the Iran nuclear accord, it’s unlikely to knock global financial markets out of the trend that’s become entrenched in recent weeks.

European stocks rose for a fourth-straight day on Wednesday, boosted, rather than buffeted, by what UBS Group AG’s wealth-management unit called “modestly higher” oil prices. Currencies of energy-producing nations were mixed against a dollar that has strengthened on six of the past seven days. Haven assets including gold declined, U.S. junk bonds appeared unperturbed, and while Treasury yields rose, that was at least as much due to the preoccupation with upcoming supply as it was down to the implications for inflation.

Dollar as `Wrecking Ball' May Blot Out Iran's Market Impact

Investors have reasons to be wary of attaching too much importance to the developments in Iran. First, the move by President Donald Trump was well flagged and already factored into prices. Second, energy firms may have ways to mitigate the impact on oil supply. Third, the prospect of a compromise remains -- and after seeing a boom and bust in aluminum prices caused by U.S. sanctions on Russia, investors have reason to be wary. Finally, the oil market had already lost some of its sway on other asset classes.

“Other than the oil sensitive sectors (oil, airlines, etc.), it’s not a huge concern,” James Soutter, the head of global equities at K2 Asset Management in Melbourne, wrote in an email. “What has been a bigger issue is the strong U.S. dollar.”

‘Grind Higher’

The U.S. will withdraw from a 2015 deal that had eased sanctions on Iran in exchange for curbs on its nuclear program, Trump said Tuesday, seeking to cut its oil exports and giving buyers 180 days to reduce purchases from the Islamic Republic. America left the door open for countries to seek “significant reduction exceptions” at the end of the notice period if they reduce the volume of purchases during that time.

Having erased all this year’s losses earlier in the week, European stocks extended gains on Wednesday. Energy firms contributed to the rally, including French oil giant Total SA, which has said it will pull out of a joint venture in Iran if Trump re-imposes sanctions and it can’t win an exemption. The S&P 500 Index also climbed.

“Stocks can continue to grind higher over the intermediate term, supported by strong global economic upside and earnings growth,” Mark Haefele, the global chief investment officer for the UBS investment unit, wrote in a report published May 8.

Durable Dollar

Foreign-exchange markets did take some direction from the higher oil prices, though boosts to currencies of commodity producers such as the Norwegian krone and Canadian dollar simply left them flat on the week, while the Mexican peso could only edge higher.

The dollar has climbed against all of its 31 major peers in the past month, with emerging-market counterparts sliding the most. Moreover, correlations between the dollar and so-called commodity currencies have been weaker this year than in 2016, when oil recovered from the lowest prices in more than a decade.

“The stronger U.S. dollar, which is running like a wrecking ball through global capital markets, is one of the more significant issues,” said Stephen Innes, head of trading for Asia Pacific at Oanda Corp. “The market is preparing for higher U.S. interest rates and the long-awaited draining of the QE punch bowl. Both of which are bad for equity markets.”

Bond Bets

That’s not say the oil price isn’t moving market-based measures of headline inflation expectations. U.S. 10-year note yields rose back above 3 percent for the first time this month, and yields on inflation-linked bonds jumped.

But high-yield energy notes have failed to keep pace, which could indicate skepticism over the sustainability of oil gains, according to Bloomberg Intelligence analyst Spencer Cutter. And global purchasing manager indexes have trumped crude prices as drivers of market sentiment, Goldman Sachs Group Inc. analysts wrote in a May 7 report.

Dollar as `Wrecking Ball' May Blot Out Iran's Market Impact

Traders may also be recalling aluminum’s surge of as much as 37 percent in the space of two weeks on the back of U.S. sanctions on Russian output -- a move that was followed by an even swifter 20 percent reversal.

“It’s not clear just how impactful the sanctions will actually be given that the other signatories to the Iran deal have not supported the move,” said Kerry Craig, a Melbourne-based global market strategist with JPMorgan Asset Management. “There is still a six-month window of negotiation to be had and the markets may be hoping for a successful resolution.”

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