Will 2025 Bring Change? A Week in Review

The air is thick with uncertainty as we look towards 2025, captured perfectly by the question lingering in everyone’s minds: Will they or won’t they? As geopolitical tensions erupted in the Middle East, the spotlight focused on the potential U.S. military action against Iran—and action was taken. Despite the chaos, financial markets appeared surprisingly calm, but the real intrigue lies in Iran’s impending response.

Ripples in the Oil and Gas Markets

The U.S. dollar showed signs of stability last week, although it avoided any significant gains amidst the ongoing turmoil. All eyes are now fixed on how Iran will retaliate after attacks on its nuclear sites. In the oil and natural gas sectors, prices surged as events unfolded in the Middle East. However, for these commodities to maintain or increase their value, a noticeable and sustained reduction in supply is crucial—though this remains an uncertain prospect.

Currently, Iran produces around 3.3 million barrels of oil daily, a quantity that could be easily offset by OPEC’s surplus capacity of nearly 5.7 million barrels per day. Saudi Arabia alone has the ability to tap into an additional 3 million barrels. Iran might consider launching strikes on pivotal facilities such as Abqaiq or targeting vessels crossing through the strategic Strait of Hormuz, which transmits about 25% of global oil traffic. However, disrupting shipments could harm their primary ally, China, which receives Iranian oil. Despite these heightened tensions, shipping through the Strait maintains a routine pace.

The European Energy Landscape

Europe, heavily reliant on energy imports, finds itself under the threat of rising oil and gas prices. While we anticipate oil prices will weigh on European inflation into 2025, they’re expected to stabilize below $85 per barrel. Although Europe is less dependent on gas from Qatar (passing through the Strait of Hormuz) than it was during the Russian gas supply collapse of 2022, vulnerabilities remain.

In contrast, the broader financial landscape appears to be largely unfazed by the Middle Eastern crisis, somewhat aligning with historical trends. For instance, since the onset of the Israel-Hamas conflict on October 7, 2023, the S&P 500 Index has risen by over 40%.

The Fed’s Steadfast Stance

This past week, the Federal Reserve opted to keep its benchmark interest rate unchanged, reflecting a wait-and-see approach as they monitor the effects of current policies on hard economic data. While some signs of distress are emerging in the labor market, they aren't substantial enough to provoke any shifts in policy just yet.

The latest Summary of Economic Projections, or “dot plot,” suggests a slight shift in outlook, with some members now predicting no rate cuts this year, compared to earlier predictions of reductions. This hawkish sentiment, however, did not lead to a substantial boost for the U.S. dollar. Investors remain wary regarding the Fed's independence amid ongoing political rhetoric calling for drastic rate cuts.

England and Japan: A Dovish Approach

Across the Atlantic, the Bank of England adopted a more dovish tone during its recent meeting, despite leaving interest rates untouched. Recent inflation figures indicated a slowdown, leading some officials to advocate for a rate reduction. Concurrently, retail sales data revealed a disappointing downturn, stirring concern regarding the economic outlook.

Meanwhile, the Bank of Japan maintained its current rate levels amid global uncertainties, eyeing potential disruptions from rising bond yields. In response to these developments, the BOJ hinted at a possible slowdown in bond acquisitions.

Surprises from Scandanavian Banks

In a surprising twist, Norway’s Norges Bank cut interest rates by 25 basis points, a significant shift as they had previously lagged behind in the cutting cycle. The Swiss National Bank, in line with expectations, also lowered rates, proving to be a unique case given Switzerland’s ongoing battle with low inflation rates.

Shifting Perceptions on U.S. Assets

Evidence is surfacing that foreign investors are becoming increasingly cautious regarding U.S. assets. Recent data indicated a modest decrease in foreign holdings of U.S. stocks and long-term securities, with Canada notably selling off U.S. Treasuries in record amounts. While this trend isn’t indicative of a widespread capital flight, it does hint at a cooling sentiment towards the U.S. market.