As crude oil prices retest and push beyond the highs seen in the wake of the drone strike on Saudi Arabia last year, risk assets have started the week on the back foot with Asia markets starting the first full trading week of the year with sharp falls, as concerns increase about further escalations between the US and Iran.

With European markets also falling sharply on the open, investors are now faced with the prospect of weighing up whether this down move has further to go, or is just another opportunity to buy the dip. It should also be noted that in spite of the weakness of the last couple of days we are still within touching distance of recent multi year highs for both the DAX and CAC40.

Now that a US, China phase one trade deal looks set to be signed by the middle of this month, markets will now have to contend with the prospect of a sustained heightened state of tension between the US and Iran for months to come in the wake of last week’s killing of General Soleimani, with some concerns that we could see a slide towards open war.

For now the tension is being raised by rhetoric, with Iran saying it would no longer comply with the nuclear deal, while the US has said it would retaliate against up to 52 Iranian sites if the Iranians responded to last week’s events, with violent acts.

It is noteworthy that both Russia and China have urged restraint on the part of both parties, with both actors likely to bring pressure on Iran to not over reach in their response, and this could be key in amongst all of the heat and light of recent days. Saudi Arabia are also sending a delegation to Washington to urge caution on the part of the US, given their proximity to recent events.

The rise in oil prices also brings with it concerns about the impact on the global economy, already fragile from a weak manufacturing sector and slowing consumer demand. Further sharp gains towards levels last seen in May last year at $75 a barrel, and the 2018 peaks above $80 a barrel could derail what in the past few months have been some faltering signs of a rebound in economic activity, with US oil prices already above last September’s peaks.

The latest services PMI’s serve to underline these concerns given recent improvements in the headline numbers from Spain, Italy, France and Germany. Today’s December numbers show that economic activity in Spain and Italy improved to 54.9 and 51.1 respectively. France services also improved to 52.4 as did Germany to 52.9, a big jump from the previous month.

Gold prices have also surged hitting their highest levels since April 2013, as investors mitigate the risks of recent events, hitting $1,587 an ounce which is also 61.8% retracement of the entire down move from the record highs  at $1,921 in 2011 to the 2015 lows.

 

Airline stocks in particular have come under pressure as a result of the sharp rise in oil prices with British Airways owner IAG near the bottom of the FTSE, with Air France also lower on the CAC40, along with Norwegian.

On the plus side BP and Royal Dutch Shell are reaping the benefits of the higher oil price, and this is helping mitigate the extent of the decline on the FTSE100.

US markets look set to follow the lead of markets in Asia and Europe, with a sharply lower open expected as the latest economic data takes a back seat to overarching geopolitical concerns.

Friday’s Fed minutes showed that US central bank policymakers had confidence in the overall US economic outlook, along with expectations about the path of interest rates. Recent events could well derail this outlook given that oil prices in the US have risen sharply since that meeting, already $4 higher and at their highest levels since April last year.

After a disappointing manufacturing report on Friday US investors will be hoping that the latest services reports have continued to hold up well.

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