A scary day in global markets

As oil prices rose sharply yesterday, things started to look scary in global markets

Yesterday started to look scary in global markets. Oil tanker traffic through the Straits of Hormuz has essentially ground to a halt and - for a few hours yesterday morning - oil prices looked like they were about to go vertical. That caused the Dollar to spike, especially against emerging markets (EM), which can have all kinds of adverse knock-on effects. When EM currencies come under severe depreciation pressure, EM central banks sell US Treasuries so they have Dollars to sell in the open market to slow the fall in their currencies. That in turn can destabilize the basis trade, which is what happened in March 2020 when COVID hit. What stopped this dynamic yesterday is that the US promised it would escort and insure oil tankers going through the Straits of Hormuz. That halted the sharp rise in oil prices, but it doesn’t remedy the problem entirely. Iran may simply start lobbing rockets at oil production facilities in the region, so global oil supply is still under severe threat. Markets remain at risk of discontinuous moves that may be profoundly destabilizing.

I introduced the above panel of charts yesterday. It compares - in event time - price action in key assets during the current shock with what happened in the days after Russia invaded Ukraine. That invasion caused a sharp rise in oil prices as markets worried about Russian oil being shut out from global markets. What’s clear from these charts is that - even after the US promise to escort and insure oil tankers - the rise in oil prices and the rise in the Dollar exceeds what happened in 2022 on a comparable timeline. All it takes is one Iranian rocket for this fragile equilibrium to pitch into severe discontinuity. The unfortunate fact is that Iran sits on top of one of the key global chokepoints. The threat of one Iranian rocket hitting paydirt remains real and this isn’t something that can be remedied any time soon.