Deadline looms as crude oil advances further

USD: Trump’s resolve looks set to be tested

The Brent crude oil price has advanced a further 3% today as tonight’s deadline of 8pm EST, set by President Trump approaches without any signs of Iran opening up the Strait of Hormuz. If Trump is true to his word the passing of this deadline without action from Iran will result in all-out attacks on infrastructure and energy assets calling the period passing that deadline “Power Plant Day, and Bridge Day”. But despite this looming threat of a notable escalation in the conflict, risk assets are trading relatively resiliently. The S&P futures contract is down about 0.5% while Asian equity market performance is mixed. The Topix in Japan is modestly higher while the Taiwan Taiex is up 2%. The resilience partly reflects positive earnings results from Samsung with a surge in operating profit due to strong demand for AI memory chips.

But in addition to that investors continue to assume the extreme risk related to oil supply disruptions will be short-lived. The spread between the most active front futures contract and the 3^rd contract for Brent crude oil shows how quickly investors continue to expect the price to retrace back lower again. During the early part of the Russian invasion of Ukraine this spread was negative showing higher prices over the months ahead versus the most active contract but not on this occasion with the reversal of price spread similar to the initial period during covid. That optimism reflected in the futures curve of a sharp retracement in price could well be tested in the coming days if there is an escalation that includes energy asset attacks and if Iran is in a position to retaliate. The backwardation in the curve may also reflect the indication of a gradual re-opening of the Strait of Hormuz with Iran appearing to allow a greater number of “friendly” tankers through although under a scenario of an escalation it would be surprising if that were to continue. A 10-point plan was delivered by Iran via Pakistan and Trump stated yesterday that it was a “significant proposal” but “not good enough”. Could this be the path to an off-ramp later? It’s certainly possible.

The newsflow of late certainly suggests Iran has the ability to continue to attack, albeit those attacks have lessened considerably. A petrochemical plant in Saudi Arabia was hit today according to AFP. Gulf Today reported that the UAE had intercepted 12 ballistic missiles, 2 cruise missiles and 19 drones launched from Iran yesterday.

The FX market continues to trade in relatively narrow trading ranges and there is limited evidence of any pick-up in volatility at this stage. The risks are surely rising but the resilience of global equity markets has continued to act as a containing influence on FX volatility. The VIX Index yesterday closed at 23.9, the lowest close since 17^th March as optimism over AI-related resilience continues. The strong US jobs data last Friday (178k) has also helped ease concerns over an imminent downturn in the US economy. All that said, if Trump follows through on his threats, we would expect to see a broad-based increase in volatility and with that some strengthening of the US dollar.  

FRONT OIL SPREAD VS 3RD CONTRACT SHOWS OPTIMISM ON PRICE DROP

Source: Bloomberg, Macrobond & MUFG GMR

USD: Inflation impact from conflict in focus this week

The fact that the traffic through the Strait of Hormuz is reportedly picking up may well help to cap the price of crude oil over the short-term (and explain that backwardation) but the inflation and growth risks will continue to increase going forward and this week will provide some insight into the initial inflation impact with the release of the March CPI report on Friday. The headline MoM CPI rate is expected to pick up from 0.3% in February to 1.0% in March – that would be the biggest gain since June 2022 soon after the start of Russia’s invasion of Ukraine.

The inflation hit from the Middle East conflict will feed through quickly and yesterday’s ISM Services report revealed a sharp jump in the Price Paid index, from 63.0 in February to 70.7 in March, the highest reading since October 2022. The one-month change in the index level was the largest since 2012. This price shock could in fact prove more impactful than expected and the strong non-farm payroll reading last Friday for March may prove to be a false signal of the current strength of the labour market. The speed of inflation shock can turn business sentiment suddenly and certainly the ISM Services report revealed a notable weakening in labour market conditions. The Employment Index plunged to 45.2, the lowest reading since December 2023, which was the lowest reading since the pandemic in 2020.

The price of gasoline is one inflation channel where the impact of the conflict is very evident to see. The price increase in the AAA daily gasoline per gallon price in March was 36.2% and the price so far in April has continued to gain each day. The increases have not yet had a notable impact on consumer confidence but that is likely to change over the coming weeks as the inflation impact broadens out, especially if the ISM Services employment index is correctly indicating a downturn in the jobs market.

The minutes from the FOMC meeting in March will also be released this week (Wednesday) and is likely to reveal division over the policy outlook ahead. The median dot for 2026 revealed in March was 3.375% - implying one rate cut this year. But the assumption built into that median dot was very much a weak labour market and hence the danger over the short-term is for the rhetoric to skew more hawkishly following the NFP data last week. Cleveland Fed President Beth Hammack yesterday stated that she saw scenarios for both cutting and hiking rates.

We continue to see greater prospects of Fed rate cuts ahead although the NFP print could push the timing further out. The US economy is on a much weaker footing now compared to the last inflation shock and we would point to the more muted gain for the dollar on the back of the substantial gain in crude oi prices as evidence of that. The dollar (DXY) is about 2.5% stronger since the conflict began despite crude gaining close to 60% - a more muted FX response than implied by data in the past.

1-MTH CHANGE IN ISM SERVICE PRICES PAID INDEX – LARGEST SINCE 2012

Source: Macrobond, Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com