While Saturday's attack was not surprising, especially once the news of air space closure came through, the market was clearly not fully prepared. It could not be. Some very limited concession to the threat of an attack had been given recently, with treasury yields, for instance, falling sharply and oil prices rising. But these moves will likely prove very modest relative to the post-attack outlook.

We also have to bear in mind that equity valuations are still high and volatility is low; particularly in FX markets. All of this opens up the prospect of significant financial market dislocation. The short-term connotations of the conflict are pretty clear: higher oil prices, stronger commodities, especially gold, and strength in other safe assets such as government bonds, the Swiss franc and the US dollar.

Equities will be hit hard, and the market will clearly focus in on the distinction between energy producers and consumers. The US might have initiated these attacks alongside Israel, but its relative energy self-sufficiency compared to the likes of Europe and Japan will leave it as a ‘winner' on this score. The last outbreak of war that caused energy prices to surge was Russia's attack on Ukraine in February 2022.

However, is that a good template for what will happen now? For instance, the US dollar surged against the euro and other currencies, not just in the immediate aftermath of the first Russian strike but in the months that followed. The euro/dollar tumbled some 15% in the seven months following Russia's incursion into Ukraine. But Steven Barrow, Head of Standard Bank G10 Strategy, said it won't be the same, or anything like the same, this time for two reasons.

The first is the scale of the energy disturbance to Europe. It will be far less severe this time around, both in terms of the initial price of energy (especially gas prices) and the longevity of higher prices.

A second factor is that the US is very different today from when Russia invaded. The current US Administration has faced significant criticism for its international tactics, such as tariffs, while attacks on other countries/leaders, such as Venezuela and now Iran, have been questioned for their legality. This merely serves to feed the narrative that many have, or may, turn away from the US dollar, or at least hedge any dollar holdings more actively.

It also seems clear that the world's demand for US dollars during adverse events, whether geopolitical or financial, has declined. For instance, major central banks did not make use of Fed liquidity swaps during the Russian invasion, as they had during prior bouts of tension such as Covid and the financial crisis. Hence, this idea that an adverse event leads to a dollar ‘shortage' seems no longer to be in play.

This also suggests that the US dollar is not the safe asset it once was, with this role being increasingly taken up by the Swiss franc or, outside the currency arena, by gold. The Swiss franc might be the main beneficiary of early safe-asset demand, but there is presumably some sort of limit to this strength, at least against the euro, as FX intervention by the SNB will likely be forthcoming. But intervention has not tended to weaken the franc significantly, at least not as we see for the yen when the BoJ intervenes, even if the impact is only temporary.

Hence, Steven Barrow suspects that investors won't be wary of buying the franc because of the intervention risk. If Swiss strength limits the ability of the dollar to rally widely over a period of time, so too might developments in the yen. For the attack on Iran and subsequent surge in energy prices could undermine yen-funded carry trades, especially against currencies that are exposed to higher energy prices. Capitulation in the carry trade could weaken the US dollar against the yen as the yen rises across the board.

“While we don't doubt that early US dollar strength is likely, we doubt a long and protracted rally. If we take euro/dollar, for instance, the rough 1.15-1.20 range may well stay in place. In fact, any further decline into a 1.10-1.15 range puts the euro in the buy zone in our view”, said Steven Barrow.