The market dipped overnight breaking the lows of two days ago as Iran decided to strike an US base in Iraq with 15 missiles (no injuries), before stating that Iran concluded proportionate measures, not seeking war. This afternoon Trump is set to attend a public conference that will give us a clue of what will happen next. This morning the market has somehow bounced back retrieving half of the overnight losses and Europe is set to open down 0.6/0.7%. Of course Oil is positive 1% (touched an overnight high at 65.65) and Gold is up 0.85% at 1587 after touching an overnight high at 1611$!

The situation is far from resolution. On one side the Iran’s foreign minister proposed signing regional non-aggression pact as regional war could drag on for generation. On the other, Iran’s parliament passed a bill designating the Pentagon as terrorist, along with assessing 13 retaliation scenarios against US (it seems the weakest of those options would be a nightmare for US). 

An escalation is quite likely. Iran’s proxy allies may retaliate against the US on Tehran’s behalf. It’s not just about Iran or the Quds Force, they have allies, Hezbollah and other organizations such as Kataib Hezbollah in Iraq, the Houthis in Yemen and possibilities outside. The USA raised max alert in the Middle East.

One explanation of market’s resilience might be the current excess liquidity which is suppressing volatility. While higher than a few weeks ago, 30 day realized volatility for the S&P 500 is still just 7.3% which is in the first percentile for the past 100 years.  It is not a coincidence that after the Fed’s temporary/permanent open market operations and the monthly purchase of $60Bln in T-Bills (Non-QE), the market was able to break out of its well-defined channel that had contained it since January 2018.

As expected, yesterday, the Spanish Parliament approved the Sanchez’s bid to form government. It’s the first coalition government since before the rise of dictator Francisco Franco, and it’s not a good news for Spanish banks as the anti-austerity group Podemos has plans to reform the sector (Will it be like M5S on ASPI/Atlantia Saga? Big words no actions?). The new government’s first test will be passing a budget for 2020, to include higher taxes for large companies and more social spending.

Macro-wise, in Europe we the inflation accelerated to the fastest pace in eight months in December, driven by energy prices. The pickup to 1.3% in December from 1% in November was in line with economists expectations. The core rate, which strips out volatile components such as energy, remained stuck at 1.3%. Separately, Eurostat said on Tuesday retail sales in the euro area rose 1% in November from the previous month, marking its first gain since August.

Good set of data yesterday in US, possibly driving USD outperformance, +50bps. The US non-manufacturing ISM index level was roughly in line with the U.S. economy growing close to potential, at 55 vs 54.5 in December, the highest level since August. Also, factory orders and capital goods were stronger than expectations. Taken together, it provides a welcome boost to economic sentiment, despite a terrible ISM Manufacturing earlier last week. Indeed, US trade deficit narrowed to a more than three-year with lower imports and slightly higher exports. The overall narrowing continued to reflected a drop in imports from China, which fell 22% in November.

Finally, check out this really interesting statistic on gold. It seems that, along with an inverse relationship with real interest rates, gold price movements are explained by the dollar over the long run. The 120 days correlation Gold vs USD is a bit stronger than -0.5 over the past 15 years. It makes sense if you think that lower real rates are leading to a lower dollar and then higher gold price.

Correlation USD vs Gold