A tentative deal is on the table. Which assets could benefit?
- The US and Iran have signed a memorandum of understanding.
- Markets are cautiously optimistic
- Stock markets were already optimistic, and have become even frothier.
The US and Iran have signed a memorandum of understanding. While this appears to have a little more substance to it than the other multiple reports of an end to hostilities, there are still many unanswered questions: the role of Israel, the practicalities of reopening the Strait of Hormuz, reparations, the future of Iran’s nuclear programme to name but a few.
Markets are cautiously optimistic, while stopping short of a full-throated rally. Even in the few days following the ceasefire, bond yields have been falling – the UK 10 year gilt fell from over 4.9% to 4.75% in the immediate aftermath of the agreement. Two year treasury yields dropped from 4.14% to 4.07%, even in the face of alarmingly high US inflation data. However, they remain some way short of their February levels. While a ceasefire may take rate rises off the table, it doesn’t restore the hoped-for rate cuts.
Corporate bonds are unlikely to see a significant rally. Spreads had never reflected any significant caution about the global economy. Aggregate corporate bond spreads moved higher in March, but have dropped back to historic lows ever since. Any gains for corporate bonds are likely to come from compression in government bond spreads alone.
The oil price has fallen, suggesting the worst fears of $150 a barrel oil prices will not be realised – at least, not if the agreement holds. Again, prices have gone back to around $80 a barrel, but are still a little way from the $60 level that investors were enjoying at the start of the year. Nevertheless, this seems a rational reaction to the fact that it will take time for normal service to resume through the Strait. China’s oil reserves appear to have been the swing factor in preventing even higher oil prices.
Stock markets were already optimistic, and have become even frothier. However, it may be that different areas of the stock market come to the fore. UK smaller companies are sensitive to gilt yields and should benefit from rate rises being taken off the table, even if cuts are still elusive. Oil and gas stocks may lose their lustre, though the whole incident has been a reminder of the importance of energy independence and it may be that alternative energy options continue to thrive. The Bank of America put consumer stocks and gold are on its shopping list for a post-conflict world.
Ultimately, it has become another reason for an already-optimistic market to be optimistic, and it means that the party can last a little longer. There are still real concerns that markets are under-appreciating the risks to the global economy, but this week saw those risks diminish a little.
