Brown Brothers Harriman’s (BBH) Elias Haddad notes that a prolonged energy shock from the Iran conflict heightens financial stability risks and supports the Dollar beyond what rate differentials imply. With Brent still below US$120 and global risk assets stalling, BBH sees USD strength near term but maintains a cyclically neutral and structurally bearish stance on the Dollar longer term.

Energy shock underpins near term Dollar

"US-Iran ceasefire odds were pared back after both countries rejected each other’s proposal to end the war yesterday. Brent crude oil prices rebounded but remain roughly 6% below the triple top at US$120 a barrel. The recovery in global stocks and bonds stalled, while the dollar index (DXY) is consolidating just above the top-end of its multi-month 96.00-100.00 range."

"Financial markets are on edge ahead of today’s deadline. President Donald Trump threatened further strikes on Iranian energy plant and bridge if Iran failed to make a deal and reopen the Strait of Hormuz by 8:00pm Eastern time on Tuesday. Trump added it was “highly unlikely” that he would extend his new deadline."

"Unfortunately, the balance of risks points to a prolong energy shock. Iran has both the capability and the incentive to destabilize global markets and impose as much economic/political pain on the US to extract maximum concessions from its five conditions for ending the war: (i) Immediate cessation of aggression and targeted attacks, (ii) Ensuring the war will not recur, (iii) Payment of war damages and reparations, (iv) Ending of hostilities across all fronts, and (v) recognition of Iran’s sovereignty over the Strait of Hormuz."

"A more persistent energy shock raises financial stability risks because it traps central banks in restrictive policy despite unimpressive growth and puts government debt on a more fragile and unsustainable path. As such, USD can continue to overshoot the level implied by rate differentials. Dollar funding needs tend to rise in periods of financial market stress due to the dollar’s dominant role in the global financial system (trade invoicing, cross border lending, global bond issuance, FX reserves)."

"Beyond the near-term, we remain cyclically neutral on USD and structurally bearish."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)