Asian equities fell on Friday, extending losses for a second consecutive week as escalating tensions tied to the U.S. and Israel’s war with Iran kept oil prices elevated and forced markets to reassess the outlook for inflation and interest rates.
Crude benchmarks hovered close to the psychologically important $100 per barrel mark, a dynamic that has undercut investor confidence and pressured risk assets. Brent futures last traded at $99.85 a barrel, while West Texas Intermediate crude was at $95.05 a barrel. Prices slipped slightly in early Asian trading after the United States issued a 30-day license allowing some countries to buy Russian oil and petroleum products currently stranded at sea, but the overall level of crude remained high.
MSCI’s broadest index of Asia-Pacific shares eased 0.5% on the day and was on track for a weekly decline of about 1.5%. Major regional benchmarks moved lower: Japan’s Nikkei fell 1.3%, South Korea’s technology-heavy market slid nearly 2%, and Taiwanese equities dropped 1%.
Investors said recent strikes and threats linked to Iran, including vows by its new Supreme Leader Mojtaba Khamenei to keep the Strait of Hormuz shipping lane closed and stepped-up attacks across the Middle East, have increased the likelihood of a prolonged conflict and the prospect of sustained higher energy costs.
Market participants reacted by moving into the U.S. dollar as a safe haven. The greenback has been the preferred refuge during the turmoil, rising roughly 2% since the war began at the end of February and setting up for a second straight week of gains. The dollar index stood at 99.599, positioned for about a 0.8% weekly rise. The euro was trading at $1.1527, slightly firmer on the day but heading for a weekly decline of nearly 1%.
Expectations for Federal Reserve rate cuts this year have been scaled back sharply. Traders now anticipate roughly 20 basis points of easing from the Fed, down from about 50 basis points priced in a month earlier, a shift that reflects concern that higher oil will keep inflation pressures elevated.
"Markets were positioned for Fed cuts this year but the runway to justify Fed cuts is no longer there with the U.S. excursion into Iran," said Prashant Newnaha, senior rates strategist at TD Securities. "The markets are recalibrating for a higher terminal rate."
The global selloff has affected both equities and bonds. U.S. stocks fell sharply overnight and two-year Treasury yields - a benchmark that often moves with expectations for Fed policy - reached their highest level in six months on Thursday before easing modestly. The two-year note yield later slipped 3 basis points to 3.730% after hitting that high. Over the two weeks since the war started, the two-year yield has risen by 35 basis points.
Longer-term government bond yields have climbed as well, with the 30-year yield up about 24 basis points for the month. Market strategists cautioned that elevated oil prices could keep volatility high and increase the risk of further market declines in the near term.
"With the possibility of higher oil prices still elevated, investors should be prepared for continued volatility and potentially further downside in the near term," said Vasu Menon, managing director of investment strategy at OCBC in Singapore.
Rising energy costs are influencing forecasts for corporate margins and inflation, rippling through expectations for rate cuts and yields. Jose Torres, senior economist at Interactive Brokers, said the combination of rising oil and weakening prospects for Fed easing is producing market volatility and leaving few safe havens.
"Indeed, sinking optimism about Fed rate reductions amid strengthening cost pressures is weighing on traditional safe havens such as silver, gold, and government debt," he said.
Gold was trading 0.7% higher at $5,114 per ounce on Friday, but it was on track for a roughly 1% weekly decline.
Currency markets showed pronounced moves. The yen firmed slightly to 159.13 per dollar, lingering near the 160 mark that has drawn attention in recent weeks. Observers said talk of possible intervention from Tokyo has been muted and that authorities may be reluctant to act when oil is adding pressure to global markets.
"What was once a 'line in the sand' at 160 has evolved into more of a moving goalpost," said Tony Sycamore, market analyst at IG. "Against such a hostile macro backdrop, it makes little sense for authorities to waste precious intervention ammunition - whether verbal or physical, trying to defend the 160ish level this time around."
Investors are also focused on an active schedule of central bank meetings next week. The Federal Reserve, Bank of Japan, European Central Bank and Bank of England are all due to announce policy decisions, with most expected to hold rates steady. The Reserve Bank of Australia, by contrast, is broadly expected to raise rates.
With crude near four digits per barrel and geopolitical risks elevated, markets appear to be in a state of heightened sensitivity to any news that could affect energy supplies, inflation or the path of central bank policy. Traders and strategists cautioned that as these dynamics play out, volatility may persist across equities, fixed income, currencies and commodities.
Summary
Asian stocks slid on Friday as renewed tensions tied to Iran kept oil near $100 a barrel, prompting investors to seek the safety of the U.S. dollar and pushing yields higher. Markets have pared expectations for Fed rate cuts, while a series of central bank meetings next week will be watched closely for guidance.
Key points
- Oil remained close to $100 a barrel, with Brent at $99.85 and WTI at $95.05, supporting inflation fears and market volatility.
- Asian equities fell - MSCI Asia-Pacific eased 0.5% - with Japan, South Korea and Taiwan benchmarks all lower.
- Safe-haven demand lifted the U.S. dollar and raised Treasury yields; traders now price about 20 basis points of Fed easing this year versus 50 bps a month ago. Gold traded higher on the day but was set for a weekly decline.
Risks and uncertainties
- Prolonged conflict or disruptions to shipping in the Strait of Hormuz could keep oil prices elevated, exacerbating inflation pressures and market volatility - impacting energy, commodities and inflation-sensitive assets.
- Rapid repricing of interest rate expectations may lead to further weakness in equities and higher yields, affecting government debt and interest-rate sensitive sectors.
- Currency volatility and constrained policy options could limit the effectiveness or likelihood of intervention in FX markets, as authorities weigh the impact of rising oil on the macro backdrop.