The market has been rising higher this week on optimism surrounding the signing of the “phase one” trade agreement between the U.S. and China, putting the two-year long trade war on ice.
On the heels of the trade truce being signed, representatives from the House delivered the two articles of impeachment against President Donald Trump to the Senate which got underway with its impeachment trial today as more evidence from the case against Trump unfolded.
These big stories have pushed the U.S. conflict with Iran into the rearview. However, JPMorgan’s global head of macro quantitative and derivatives strategy Marko Kolanovic warns that tensions in the Middle East could soon reach a boiling point.
“A significant change to our outlook is the new geopolitical tail risk that emerged in the Middle East,” Kolanovic wrote in a note to clients. “We believe this tail risk is under-appreciated by the market and should be hedged.”
Tensions between the U.S. and Iran sparked when a U.S. airstrike killed Iranian General Qasem Soleimani which Iran responded to by launching a missile attack on Iraqi bases which housed U.S. troops designed not to kill, but to deliver a warning.
Stocks initially sank lower while oil surged higher as the market wondered whether production in the oil-rich region would be impacted by a possible conflict.
But then stocks bounced back, quickly surging to new all-time highs.
While tensions with Iran seem to have cooled since the very beginning of the year, Kolanovic argues that the underlying issues between the U.S. and Iran haven’t been resolved and thus, the risks have not been removed. Instead, the two countries have been pushed “further down a collision course.”
Given that 2020 is a presidential election year, Kolanovic believes that ongoing retaliation by Iran could have a significant impact as volatility and rising oil prices could sway foreign policy decisions.
“If the conflict were to escalate in an election year, causing market turmoil, and with the US having fewer allies, Trump could be more likely to accept a JCPOA-like settlement,” Kolanovic said, adding that “the risk of escalation is high going into [the] U.S. election,” and “the market currently is not pricing any significant risk.”