Well oiled diplomacy – Rowan Dartington Signature’s Stephens comments

Rowan Dartington Signature’s Guy Stephens comments on why markets welcome nuclear agreement with Iran.

The announcement over the weekend of the agreement with Iran is the first evidence in many years of a shift in US foreign policy in the Middle East. Of particular note, and annoyance for Israel, is the revelation that secret negotiations have been taking place following the appointment of President Hassan Rouhani, a relative moderate, in August. Saudi Arabia is also nervous as this signals a US willingness to soften its support for its oil producing friends in the Middle East which could lead to other localised pressures for them.

This move would have been unthinkable without the transformation that fracking and shale gas has brought about with regard to US energy dependency. The precise detail is yet to be revealed but the oil price has fallen by almost 2% in anticipation of Iran bringing additional supply onto the market. This weakens the influence of OPEC and is therefore very welcome in terms of reducing input costs in the global economy and restricting inflationary pressure. Not surprisingly, oil majors are weaker on the news but generally the markets are welcoming of the development as there may be signs of something significantly positive occurring in the Middle East for the first time in over 30 years.

Data released over the week were also supportive in terms of the US economy. The markets over there continued to hit new highs as the tapering debate concluded that any commencement is still likely to occur after the budget and debt ceiling debates in January and February. In addition, the US authorities are unlikely to do anything to threaten the still nascent recovery until growth is robust and a sustained increase in employment is evident. Commentators refer to the economy achieving ‘escape velocity’ whereby growth is self-sustaining and feeds upon itself. If history in this area is a useful reference then the liquidity tap, aided by falling oil prices, will remain open for some time to come and especially now that any inflationary pressures will be further dampened by a weakening oil price.

On the negative side, there was further evidence of strain in the Chinese banking system with elevated overnight swap rates at recent highs. This supports the recent cautionary comment from Angus Tulloch and his team at First State, who recently informed us of possible bank failures. That said, the authorities have absolute control over their banking system and most are not plugged into the global system as in the West so we remain wary and underweight to the region but not overly nervous at this juncture.

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