There was an interesting observation in The Sunday Times last week by
Carne Ross, a former British diplomat who resigned in protest at the Iraq war. Ross explained how “a former colleague, now a senior official in the Foreign Office, told me recently that in 30 years of diplomacy he had never seen so many critical foreign policy problems at once in which Britain was irretrievably entangled. But incredibly, he remarked as he gazed out at shopping crowds on the street, life goes on as normal.”
Life does indeed go on as normal – and not just for shoppers. The financial markets, whose job it is to assess and price risks, seem remarkably unfazed too. For diplomats, the invasion of Iraq was a disaster that damaged alliances, destabilised the Middle East and left the world a more dangerous place. Yet for investors, the Iraq war marked the start of a remarkable bull market that shows no signs of running out of steam. Even these past few weeks, with the news full of talk of a possible US and Israeli attack on Iran, the markets have barely registered a ripple.
What Iran situation means for investors
Are investors right to be quite so relaxed? And if not, how can they protect themselves from the fall-out? A fascinating report by Charles Robertson and Mark Cliffe, economists at investment bank ING, tries to provide some answers. They argue that an attack on Iran may be more likely than the markets think, that the immediate impact on markets is likely to be dramatic, and that the longer-term financial consequences are uncertain.
The market seems to be betting that America and Israel are too politically weakened by their failures in Iraq and Lebanon to attack Iran. But that may be to underestimate their determination to prevent Iran getting a nuclear bomb. Whatever the official denials, America’s actions certainly look like a preparation for war. US forces in the Gulf are now at their highest level since 2003, with a second battle group arriving there this week. There also appears to be an orchestrated media campaign to prepare the ground, similar to the one waged by Israel ahead of its attack on Iraq’s nuclear facilities in 1981. What’s more, if there is an attack, it may come sooner than people think, since Iran’s nuclear enrichment programme is thought to be fairly advanced. And both Israel and the US will want an attack to take place while president Bush is still in the
White House.
The immediate impact of an attack is likely to be dramatic, not least because it would be far less expected than the Iraq war, which came after months of build-up. Oil prices would soar, given fears that Iran might try
to disrupt oil supplies through the Straits of Hormuz. Government bonds would rise and stocks would fall as investors looked to dump riskier
assets. Safe havens, such as gold and commodities, would do well. But the
American dollar would probably fall amid fears of a terrorist backlash;
the beneficiaries would be currencies such as the Swiss franc and Japanese yen, both of which currently look undervalued. Emerging market stocks and bonds, particularly those of Israel, Turkey and Egypt, look especially vulnerable. But oil stocks, such as BP and Shell, would benefit from higher
oil prices.
The consequences of a US attack on Iran
How long these effects last depends on how Iran responds. Any attack would most likely be an Israeli air assault on Iran’s nuclear facilities, similar to the one on Iraq in 1981. In that case, it could all be over in a few days.
How could Iran retaliate? It could try to bomb Israel – but Israel has faced attacks before and, with US naval forces on hand, should be well defended.
It may also try to close the Straits of Hormuz, but it never managed this during the Iran-Iraq war (except reportedly for 17 hours in eight years). With such a big US naval presence, it would struggle to do so now. It could also try to stir up trouble in Iraq and among other US allies in the Gulf,
but this would only intensify its diplomatic isolation and, anyway, is unlikely to succeed in toppling regimes. What’s more, Iran would have to weigh up any reprisals against the prospect of a massive US counter-strike.
All this suggests Iran’s options may be limited. In that case, the markets might bounce back quickly, just as they did after the Iraq war started and after the London and Madrid terrorist attacks. So perhaps the markets are right to be relaxed after all. But all this depends on any attack being over quickly.
If the attack drags on, as Israel’s attack on Lebanon did last year, the outcome could be far more uncertain. There would probably be a global political backlash and it is unclear how other Middle Eastern countries might react. Then the panic in the markets would be sure to spread. That may not be the most likely scenario, but it is one that should worry every investor – even if it doesn’t yet seem to have registered with the shopper in the street.
Simon Nixon is executive editor of Breakingviews.com