By Michael Every of Rabobank
If all you focus on is Brent oil, 10-year US Treasury yields, and the US dollar, relax: they are roughly where they were at the close on Friday before Iran unleashed over 300 suicide drones, cruise missiles, and ballistic missiles at Israel: the geopolitical shock in markets today is aluminium up 6% after the London Metal Exchange banned Russian metals. However, if you think financial metrics tell you what’s going to happen in the Middle East, you don’t have a prayer.
On 14 April 1988, a US Navy vessel struck an Iranian mine in the Strait of Hormuz. The US then launched Operation Praying Mantis, and in eight hours, sank two Iranian oil platforms, three warships, several armed boats, and two fighter jets, a blow that helped end the long Iran-Iraq War. That US was the emerging global hyperpower, as the Soviet bloc and USSR slid towards collapse; “geopolitics” meant US muscle opening the way for global US-style capitalism.
On 15 April 2024, Operation Praying Man tis, with the US far weaker militarily and unwilling to use full force against the combined challenge of Iran, Russia, China, and North Korea; “geopolitics” means a US retreat, as elite American youth rejects both capitalism and America.
What just happened between Iran and Israel was not the start of WW3. However, neither was it “geopolitical theatre" with fake violence, like a WWF match. It was deadly serious, has huge implications for markets, and is likely not over yet.
We saw the extent and limits of US/Western/Israeli power:
- Shooting down 99% of the drones/missiles fired at Israel was a remarkable military achievement that will prove a (pricey) template for others (as Ukraine suffers without such a shield). However, this was only a small fraction of the arsenal Iran and Iranian-proxy Hezbollah hold, and they will have now learned how to recalibrate to try to overwhelm Israel’s defences next time.
- As remarkable was a defence alliance of Jordan, the Saudis, the UK, France, and the US, helping shoot down Iranian attacks. However, this may not hold up to regional political pressures.
- The economic cost of the defence was staggering - $1.3bn for one night. The attackers paid far less. As with Ukrainian drones vs. the Russian Black Sea Fleet and the Houthis vs. the West’s Operation Prosperity Guardian, which is not guarding anyone’s prosperity, if military attack is now multiple times cheaper than defence, the inverse of the past, then we can expect a lot more global attacking to be done.
- A clear loss of US deterrence is evident given President Biden told Iran’s Khameneni "Don't!" – and he did anyway, as Putin did before him. Biden is also telling China’s Xi “Don’t!” on Taiwan and the Philippines. It’s not clear if Biden told Israel’s Netanyahu “Don’t!” on striking back against Iran, which the Israeli media says its war cabinet had decided to do on Saturday night but delayed after a phone call with the US. But the US clearly looks weak on many fronts.
Israel has apparently decided to counterattack – just not yet when, where, and how. However, Iran’s new redline is any strike on Iranians anywhere will see it hit Israel directly, and escalate; and a shocked post-10/7 Israel needs to show Iran that when it uses proxies to hurt it, Iranian territory will feel the pain too. Regardless of any talk about “de-escalation”, or the fact the US and Iran don’t want full-blown war, that escalation-ladder geopolitical dynamic should be clear.
Iran has said it will attack US forces in the Middle East (again) if the US helps Israel hit it. The US has said it will not join in any attack, as rumors swirl Qatar and the UAE forbade the US from using its military bases in their countries for strikes on Iran this weekend. However, this does not mean the US won’t help defend Israel (again), or that it will necessarily oppose an Israeli strike: it just wants to be informed in advance this time.
Israel faces a choice between responding to what Iran did (little damage), and what it tried to do (over 300 times the Israeli strike on Damascus). Both carry huge risks.
Israel can keep its new-found support and regional alliance, and the US happy, but it will lose crucial deterrence at a very dangerous time. It would also mean repeating what its public sees as the failed "high tech defences and hope" strategy employed in the past vs. Hamas.
Iran is meanwhile winning the regional long game of a slow-grind, proxy-based “War Between Wars”, and is moving closer to a nuclear weapon: Jerusalem may see this as its last window to act on that existential threat given the ADHD West --briefly-- views it with sympathy again. Traditionally cautious PM Netanyahu, slumping in the polls, has always been fixated on Iran, and heads a far-right coalition calling for a counterstrike; there may even be a presumption the US would be forced to step in if things escalate. Yet an Israeli attack risks opening Pandora's Box: it could fail; and there is no ‘one and done’ - what if Iran then got help from Russia and China? (As China is accused of playing a large role in Russian military rebuilding.)
One “de-escalatory” way out might be for Israel to accept strong G7 sanctions against Iranian energy and ballistic missile production. Yet while the G7 has unequivocally condemned in the strongest terms Iran’s attack on Israel, expressed full solidarity and support to Israel, reaffirmed its commitment towards its security, and “stands ready to take further measures now and in response to further destabilizing initiatives”, nothing concrete has been proposed. What would be required to hurt Iran would push energy prices higher, which none of the G7 will accept. After all, we already see the West won’t impose tough secondary sanctions on Central Asia or China because it won’t face the pain needed for a real economic war.
So, with or without sanctions on Iran, over time the geopolitical risks lean towards further upside for energy prices, as we flagged immediately after the 10/7 Hamas attack on Israel (along with saying that the Suez Canal might be closed).
Relatedly, lost in all this noise is last week’s Iranian hijacking of an Israel-linked container vessel in the Strait of Hormuz and the kidnapping of its Filipino/Indian crew: that suggests the need for a larger US Navy presence in Hormuz as well as the Red Sea. In which case, where are the vessels needed for the Indo-Pacific as tensions rise there?
This is the unstable global security architecture markets sit atop while making their torch-on-a-wall forecasts: one wrong move --as predictable moves keep being made-- and oil prices can surge, and all economic projections are wrong. So, Operation Praying Man tis:
- Netanyahu is praying he can find the ‘right’ level of inaction or retaliation vs. Iran.
- Khomenei is praying the US/G7 force Israel to back off so it can win its regional long game.
- Biden is praying he doesn’t see a fourth geopolitical debacle that hurts him in November.
- Chancellor Scholz, doing export BAU in China, is praying we live in 2004, as Siemens suggests it will be 2074 before German firms derisk their supply chains from China. Likewise, only 14% of Austrian respondents state they are willing to fight to help the EU if it is invaded, while 72% expect the EU to fight to defend them!
And markets are praying they can pretend deteriorating geopolitics matter far less than their little models or pretty charts. Like the one showing USD/JPY at 153.42, proof the global geoeconomic and financial architecture was already at risk of breaking down even before Iran attacked Israel directly
