The agreement to reopen the Strait of Hormuz was met with swift relief in markets. But some traders worry that the rise in stocks and the drop in oil prices may be exaggerated.
WTI, the US oil benchmark, closed at US$76.60 a barrel on Thursday (18), down almost 10% in the week. The price of gasoline fell below $4 a gallon for the first time since March. US stocks are near all-time highs.
“Traders are, in some ways, pricing in perfection,” said David Oxley, chief commodities and climate economist at Capital Economics. “It’s the relief of knowing the strait is open – that’s wonderful news compared to the doomsday scenario of it being closed.”
“But I actually think (the market) may have gone a little too far,” he added. “This is not necessarily a sign that everything is going to be completely fine from now on.”
Oil
Oil futures fell and gasoline prices declined, driven by optimism that the flow of oil through the Strait of Hormuz will increase now that the U.S.-Iran deal has been signed.
However, the market may be disregarding the risks and acting more on enthusiasm than reality, analysts noted.
Traffic along this important waterway remains a drop in the ocean compared to pre-war levels. The strait was right at the center of the conflict, and insurance for ships passing through remains expensive. Doubts also persist about the presence of mines in the strait.
The agreement provides for a 60-day ceasefire period; the strait could be closed again after that deadline, or logistical concerns could arise if Tehran demands payment of traffic fees.
And how quickly will producers in the Gulf region be able to restructure their production and recover from the damage caused by the war?
“I see a pretty substantial risk that this doesn’t play out as optimistically as perhaps some are pricing in the market,” said Adam Turnquist, chief technical strategist at LPL Financial.
Actions
The S&P 500 is up 9% since the start of the war with Iran in late February. US stocks continue to rise, driven by excitement around artificial intelligence.
However, stocks fell on Wednesday after the Federal Reserve left interest rates unchanged, and traders are pricing in the possibility of a rate hike as early as September.
The stock market continues to ignore geopolitical concerns and reach all-time highs, increasing the balances in people’s 401(k) plans and retirement accounts. Falling oil prices are a boon for stocks, but until the conflict is resolved, turmoil in the Middle East remains a risk.
“The market is really optimistic about the news that a deal has been reached and so is not factoring in the risks over the next 60 days,” said Turnquist of LPL Financial.
Strait of Hormuz
As oil has fallen from its late-April peaks, Wall Street banks have lowered their forecasts for the end of the year.
Citi analysts on Monday adjusted their forecast for the price of oil to US$75 per barrel in the third quarter of this year, compared to the previous forecast of US$110.
It all comes down to the Strait of Hormuz.
Investors need to see a significant increase in traffic through the strait in the coming weeks and months at a minimum to keep prices moderate.
Still, there are logistical challenges to resuming oil production across the Gulf region.
“We’re walking a very fine line,” Turnquist said. “The market, right now, and especially the oil market, is assuming that many things will work out.”
