By Charles Robinson
** The market impact of a surprise Israeli strike on its nuclear facilities **
January 9, 2007
A HIGH IMPACT, IF LOW PROBABILITY SCENARIO?
[INSET: Top trades in the event of an attack on Iran: CURRENCIES: Buy CHF, Buy NOK; Sell TRY. COMMODITIES: Buy Oil and Gold; Sell industrial commodities. EQUITIES: Outperfom Oils, Lukoil, Gazprom; Sell Turkey/Iraq. EM BONDS: Russia/Kazakhstan; Outperform; Sell Turkey/Iraq. DEVELOPED BONDS: Buy 5yr U.S. paper; Buy Euro 10*10yr volatility; Sell Itraxx Main.]
The financial markets are assuming that an Israeli and/or U.S. attack on Iran is unlikely. However, bellicose rhetoric from Israel and an imminent build-up of U.S. forces in the Gulf suggest that they could be in for a shock.
AN IMMINENT ATTACK WOULD SEEM UNLIKELY, given the weakness of the Israeli and U.S. administrations, and hopes for regime change in Iran. However, Iran's threat to Israel's existence, and fears that it will acquire nuclear weapons within two years, suggest that President Bush may sanction action before he leaves office at the end of 2008.
HOWEVER, WITHIN A MONTH the U.S. will have two aircraft carrier battle groups and a new expeditionary Marine strike force in the Persian Gulf, which might provide a shield for an Israeli bombing of Iran's facilities. Israel reportedly has the weaponry to at least delay the nuclear program.
A KEY IMPONDERABLE IS THE EXTENT OF IRANIAN RETALIATION. Although missile and terrorist attacks on Israel and U.S. interests would be likely, the threat of massive U.S. retaliation, regional conflict, and long-term damage to its political and commercial interests might limit Iran's response.
THE FINANCIAL MARKET IMPACT WOULD BE DRAMATIC, even if Iranian retaliation were restrained. Risk assets have risen strongly over the past three years, and a surprise attack on Iran would catch out markets pricing in little votality. The U.S. dollar, government bond yields, stock markets, and industrial raw materials would all fall. Oil and gold prices could spike, boosting related equities, debt, and currencies. Other credit spreads would widen, and the unwinding of carry trades would see funding currencies benefit, although Japan, dependent on Iranian oil, might lat others such as the Swiss franc. A prime casualty might be the Turkish lira, which could fall 10-20%. The duration of these effects would depend on the extent of Iranian retaliation: a constrained response would make them short-lived.
MARKETS ASSUME NO ATTACK, AND REGIME CHANGE WOULD SUPPORT THIS
For the moment, the global financial markets regard the risk of a U.S. or Israeli strike on Iran as a remote possibility. Indeed, after their respective misadventures in Iraq and Lebanon, both the U.S. and Israeli administrations would seem to lack the political strength to carry off such an attack in the near term, preferring to hope that spontaneous regime change in Iran will reduce the threat posed by its efforts to develop nuclear weapons. Nevertheless, both remain determined to thwart these efforts. This puts a timescale of two years on possible diplomatic or military solutions, which happens to coincide with President Bush's remaining tenure.
YET RISK OF NEAR-TERM ATTACK DOES EXIST
However, later in this report, we examine the arguments that suggest that an attack on Iran's nuclear facilities, probably by Israel, may not be as remote a possibility as the markets appear to think. We outline a scenario in which Israel attacks 5 or 6 of Iran's nuclear facilities in late February or March 2007, with strikes that may be completed within hours, days, or at most weeks. We argue that direct U.S. involvement is possible, but that U.S. forces might instead act as a shield to deter Iran from escalating any retaliation beyond the expected Shahab-3 missile, Hamas, and Hezbollah attacks on Israel. Althugh the probablity of such a scenario may remain low, the impact on the global markets would be sufficiently dramatic, albeit perhaps short-lived, to warrant investors' attention. Indeed, the threat of action could impact on prices.
We start this report with our assumptions for the immediate global market reaction to such an 'imminent strike/limited response' scenario. We then discuss in more detail the background to the scenario and the alternative possiblities, including the potential for broader retaliation by Iran.
THE IMPACT ON THE FINANCIAL MARKETS
THE IRAQ CASE GIVES US SOME CLUES ON THE FLIGHT FROM RISK
The response of the financial markets to the onset of war in Iraq provides us with some clues as to how they would react to an attack on Iran (see charts below). The combination of threatened disruption in oil supplies and a general flight from risk assets might lead to:
--Surging oil prices.
--Sharp declines in stock prices.
--Sharp falls in bond yields and interest rate expectations.
--Wider credit spreads.
--Possible weakness in the U.S. dollar.
BUT HOW BIG AND LASTING WOULD THE EFFECTS BE?
Yet while the direction of the market responses might be clear cut, the example of Iraq might not give us a reliable guide to how big or lasting the effects would be:
--A sudden, surprise assault on Iran's nuclear facilities might prompt a much more sudden market reaction than we saw in the case of Iraq. The markets spent weeks in advance pricing in the Iraq conflict: indeed, such was the confidence in the initial outcome, the market responses had partially reversed in the week prior to the invasion. With an air strike, the Israelis might seek to keep the timing more of a surprise.
--The smaller scale and duration of this action relative to a ground invasion of Iraq might mitigate its impact.
--If Iran chose to direct retaliation solely at Israel -- then lasting market consequences might be largely limited to Israel alone (see later).
BUT THE IMPACT MIGHT BE GREAT THAN THIS
However, in some ways, the impact might be greater than it was in the Iraq case:
--Volatility levels in the financial markets are at record lows, and while a strike on Iran may be over quickly, its impact could be magnified by this fact.
--An assault on Iran could pose even bigger risks to international relations.
--The threat to global oil output would be substantially greater.
--The U.S. is now in a weaker military and political position than it was four years ago.
A PRICE WORTH PAYING
Such thoughts maight be seen as a serious deterrent for the U.S. supporting an Israeli attack on Iran in the first place. But it must be remembered that the U.S. administration is not viewing its agenda through an economic prism. As an administration official, when asked in late 2004 about the mounting costs of the war in Iraq put it, they pale "compared with the costs that the terrorists would like to inflict on us."
OIL -- US$65-80/bbl PLAUSIBLE
THE IRAQ SCENARI SUGGESTS OIL BACK TO THE MID-US$60s
If the market responses to the build-up to the Iraq war were replicated, this would imply a US$9/bbl increase in the oil price, taking Brent from US $55/bbl to US$64/bbl. However, this would almost certainly prove to be an underestimate given that Iranian oil production of 4m barrels per day in 2005 is double the 2m barrels per day produced by Iraq in 2002, and Iran is a bigger net oil exporter.
ABOVE US$80/bbl IS IMPLAUSIBLE UNLESS IRAN DECIDES ON WIDE-RANGING RETALIATION
More importantly, an air strike on Iran would be qualitatively different to the invasion of Iraq. While there would be no immediate threat to Iran's own oil production, the threat of Iranian retaliation against supplies from the rest of the Gulf might spook the oil markets. Panic speculative buying would quickly revive talke of US$100+/bbl oil.
1981 ATTACK HAD NO OBVIOUS IMPACT ON OIL PRICES
After an initial speculative spike in oil prices, much would then depend on whether Iran delivered on any threats to disrupt oil supplies. If an Israeli attack only met with Iranian retaliation against Israel alone, any hike in oil prices would probably be temporary. Note that after its 7 June 1981 attack on the Iraqi Osiraq nuclear reactor, oil prices were not dramatically affecte. Iran/Iraq were already at war, OPEC was in disarray, the U.S. was entering recession, and there was no Iraqi retaliation. . . .
By Charles Robertson
** Key U.S. opponents of a strike on Iran have been replaced -- Patriot missile deployment is another signal -- news agencies have warned Iran will be a major issue in an acute way. **
January 15, 2007
THE U.S. MAY ACCEPT THE IRANIAN BOMB?
In looking back over recent news stories on Iran, we found this report from the U.K. newspaper The Sunday Times, published on 1 October 2006, and titled "The U.S. may accept Iranian nuclear bomb." We have italicized the article:
“General John Abizaid, commander of US forces in the Middle East, has warned that striking Iran could cripple oil supplies, unleash a “surrogate” terrorist army and lead to missile attacks on America’s regional allies. The army is particularly concerned about Iran’s ability to destabilise an already chaotic Iraq. John Negroponte, director of national intelligence, has told President George W Bush that there is no rush to use force as Iran’s nuclear program is beset with technical errors. 'He has been saying, "Slow down, it’s not an immediate problem,"' said Patrick Clawson, an Iran expert at the Washington Institute for Near East Policy.
"Condoleezza Rice, the secretary of state, has staked her reputation on achieving a negotiated settlement with the help of the 'EU3' nations of Britain, France, and Germany.
“'President Bush is not going to take military action against the advice of the secretary of state, U.S. generals, and the director of national intelligence,' Clawson said."
Note in December General Abizaid resigned from his post and was replaced in January by Admiral Fallon. He has also responded to Abizaid's concerns, by promising to deploy anti-missile systems (see below), he has announced the deployment of an additional 21,500 troops to Iraq, while two carrier groups may help prevent any crippling of oil supplies.
In January, Negroponte was also replaced, in what was widely seen as a surprising move and a possible demotion. We have seen no convincing explanation for this move. He has been replaced by retired Navy Vice Admiral J. Michael McConnell. Bush declared that "Admiral McConnell has decades of experience ensuring that our military forces had the intelligence they need to fight and win wars."
This leaves Rice who has long been a Bush loyalist and backed the war in Iraq, but who recognizes that attempts at a diplomatic solution need to be tried before a military option. Note that in the past week she has kept the diplomatic option open. Rice has publicly suggested that if Iran stops the enrichment process, she will meet any Iranian official at any time.
The personnel issue is reminiscent of the 2002-03 period.
RICE'S TRIP TO THE MIDDLE EAST -- IRAN (STATE DEPARTMENT) OR IRAQ (BUSH'S SPEECH)?
President Bush's speech included an interesting line. He declared that "on Friday [12 January], Secretary Rice will leave for the region, to build support for Iraq and continue the urgent diplomacy required to help bring peace to the Middle East." This is a different emphasis from that reported by Bloomberg on 9 January (NI IRAN "Go"), when it cited the State Department spokesman saying that Rice Rould be going to the Middle East to discuss the "common threat" from Iran and would be "laying the foundations for potential future actions."
BUSH'S SPEECH -- PATRIOT MISSILE AND CARRIER GROUP DEPLOYMENT
Another notable paragraph in his speech "We're also taking other steps to bolster the security of Iraq and protect American interests in the Middle East. I recently ordered the deployment of an additional carrier strike group to the region." We will expand intelligence-sharing and deploy Patriot air defense systems to reassure our friends and allies. We will work with the governments of Turkey and Iraq to help them resolve problems along their borders. And we will work with others to prevent Iran from gaining nuclear weapons and dominating the region." (http://www.spiegel.de/international/8,1518,459047,00.html)
We have already noted that in our *Attacking Iran* report of Tuesday, 9 January that the deployment of two carrier groups (one arrived in December already, the second should arrive within ,2-3 weeks) implies the use of force. This is not a normal  rotation of forces. The deployment of Patriot missiles would be needed if the U.S. feared ballistic missile attack -- e.g. from Iran's Shahab-3 missiles. It will be curious to see if these go only to Israel or also to GCC states.
WHITE HOUSE WARNS NEWS CHANNELS THAT IRAN WILL MOVE UP THE AGENDA
“At a not-for-quotation pre-speech briefing on January 10, George W. Bush and his top national security aides unnerved network anchors and other senior news executives with suggestions that a major confrontation with Iran is looming. Commenting about the briefing on MSNBC after Bush’s nationwide address, NBC’s Washington Bureau Chief Tim Russert said 'there’s a strong sense in the upper echelons of the White House that Iran is going to surface relatively quickly as a major issue -- in the country and the world -- in a very acute way.” Russert and NBC Anchor Brian Williams depicted this White House emphasis on Iran as the biggest surprise from the briefing as Bush stepped into the meeting to speak passionately about why he is determined to prevail in the Middle East. http://www.consortiumnews.com/2007/011107.html
INVESTMENT IMPLICATIONS: GEOPOLITICAL TENSION WILL LIKELY RISE IN FEBRUARY/MARCH, IMPACTING ON RISK APPETITE AND ASSET PRICES ACCROSS THE BOARD.
--Charles Robertson, London (44 20) 7767 5310
MAJOR INVESTMENT BANK ISSUES WARNING ON STRIKE AGAINST IRAN
By Michael Roston
** Bank sees February or March timeline if Israel strikes **
January 15, 2007
Warning that investors might be "in for a shock," a major investment bank has told the financial community that a preemptive strike by Israel with American backing could hit Iran's nuclear program, RAW STORY has learned.
The banking division of ING Group released a memo on Jan. 9 entitled "Attacking Iran: The market impact of a surprise Israeli strike on its nuclear facilities."
ING is a global financial services company of Dutch origin that includes banking, insurance, and other divisions. The report was authored by Charles Robinson, the Chief Economist for Emerging Europe, Middle East, and Africa. He also authored an update in ING's daily update, *Prophet*, that further underscored the bank's perception of the risks of an attack.
ING's Robertson admitted that an attack on Iran was "high impact, if low probability," but explained some of the reasons why a strike might go forward. The Jan. 9 dispatch, describes Israel as "not prepared to accept the same doctrine of ‘mutually assured destruction’ that kept the peace during the Cold War. Israel is adamant that this is not an option for such a geographically small country. . . . So if Israel is convinced Iran is aiming to develop a nuclear weapon, it must presumably act at some point."
Sketching out the time line for an attack, Robertson says that "we can be fairly sure that if Israel is going to act, it will be keen to do so while Bush and Cheney are in the White House."
Robertson suggests a February-March 2007 timeframe for several reasons. First, there is a comparable situation to Israel's strike on Iraq's nuclear program in 1981, including Prime Minister Ehud Olmert's political troubles within Israel. Second, late February will see Iran's deadline to comply with U.N. Security Council Resolution 1737, and Israel could use a failure of Iran and the UN to follow through as justification for a strike. Finally, greater U.S. military presence in the region at that time could be seen by Israel as the protection from retaliation that it needs.
In his Jan. 15 update, Robertson points to a political reason that could make the assault more likely -- personnel changes in the Bush administration may have sidelined opponents of attacking Iran.
Preisdent Bush recently removed General John Abizaid as commander of U.S. forces in the Middle East and John Negroponte as Director of National Intelligence, both of whom have said attacking Iran is not a priority or the right move at this time. The deployment of Patriot missile batteries, highlighted in President Bush's recent White House speech on America's Iraq policy, also pointed to a need to defend against Iranian missiles.
The ING memo was first sent to RAW STORY as an anonymous tip and confirmed Monday by staff in the bank's emerging markets office, who passed along the Jan. 15 update. The full PDF documents can be downloaded at this link for the Jan. 9 report, and this link for the Jan. 15 update. A screenshot of the first page is provided below.