The US-Israel attack on Iran has thrown the whole Forex market into disarray, upending themes that drove the market over the last month. Some of the biggest movers in February have completely reversed course, while others have intensified their gains. Some assets that normally are fellow travellers have diverged dramatically. Here are some ways the war in Iran is rewriting the Forex playbook, along with a couple of things to watch out for.

February was a month of normalisation for the markets, particularly for precious metals. Both gold and silver shot up in January, driven in large part by Chinese retail traders. The subsequent crash and the Chinese Lunar New Year left both metals trading at more normal velocities, although both trended higher. They were aided by a general risk-off theme in markets, as traders exited high-flying tech stocks and sought better value. This also supported the Euro, which got so strong that the ECB started to worry it might affect consumer prices. Asian stocks rose, with yen weakness helping the Nikkei score several new record highs. That has all dramatically changed.

Why Are Gold and Silver Diverging?

After the start of the war in Iran, markets naturally piled into safe havens, which traditionally include precious metals. Gold shot up, but silver did not go with it this time. That is largely due to China. While gold is primarily seen as a store of value, about half of silver demand is driven by industrial use, with its primary use being in solar panels.

EV sales in February underperformed, with that information only being reported in March, dampening some of the energy transition demand. China is a massive consumer and manufacturer of solar panels that would power the transition to EVs, and it leads in both areas. But it is also the world’s largest importer of crude to support its manufacturing industry. Not only that, but solar panels use an important amount of petroleum-based resins in manufacturing. A prolonged conflict with Iran that keeps the Strait of Hormuz closed could cause crude prices to rise, slowing industrial activity in China, and reducing demand for silver.

Yen Weaker Despite Safe Haven Flows

The yen is one of the traditional safe-haven flows and benefits from low interest rates as a source of carry trades. The currency was already weaker in February after Prime Minister Sanae Takaichi won a landslide victory in snap elections, clearing the way for increased deficit spending.

The yen has weakened even more since the start of March, because Japan imports nearly all of its crude. With oil prices spiking, this could substantially increase inflation and weigh on industrial demand. The Nikkei stock index dropped sharply on Tuesday, signalling increased currency outflows, as investors worry about Japanese companies’ ability to generate profits amid high energy costs.

Euro Under Pressure Despite Not Participating

A similar situation is happening in Europe. Before the war started, the ECB was on alert for a too-strong currency that would put deflationary pressure on the economy. Meanwhile, the European economy was accelerating, attracting investors. Europe’s low weighting of tech stocks meant that the rotation out of high-valuation equities would benefit European stock markets and attract investors to the Euro.

However, a prolonged period of higher crude prices could raise costs across Europe. That would put pressure on companies already struggling with low margins and raise consumer prices. While that would likely pressure the ECB to take a more hawkish stance, the higher interest rates would threaten economic growth, and therefore weaken the Euro.

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