Dubai: The easing of US-China trade tensions may have helped investors start the year strong, but an escalating conflict between the world’s top economy and Iran is seen turning sentiment sour this week.

Global stock markets continued its 2019 momentum and hit fresh record highs at the start of the new year, but gains were cut short and indices were pushed deep into the red after a US air strike killed a top Iranian commander and the Middle Eastern country vowed “severe retaliation”.

The event pummeled US stocks on Friday, with the S&P 500 falling 0.7 per cent, the Dow Jones Industrial Average shedding over 0.8 per cent and the Nasdaq Composite Index also dropping 0.8 per cent.

However, the impact was most felt in regional stock markets on Sunday. Dubai’s DFM General fell 3.1 per cent, Abu Dhabi’s ADX slipped 1.4 per cent, main indices in Saudi Arabia and Qatar dropped over 2 per cent and Egypt’s EGX fell 4 per cent. MSCI Inc’s index of emerging-market stocks fell the most in more than a month.

“Going forward, the rising geopolitical uncertainties could continue to weigh on investor sentiments and lead to volatility in the short-term,” said Iyad Abu Hweij, managing director at Allied Investment Partners PJSC. “For the Middle East and Northern Africa region, investors will turn cautious due to the heightened risk in geopolitical environment and further escalations could lead to downward pressure in regional equities.”

This is the second time geopolitical risks have flared up in the region in recent months. Volatility surged in September after the Aramco drone strikes highlighted the vulnerability of Saudi Arabia’s oil installations. Iran-backed Houthi rebels in Yemen, who’ve launched several drone attacks on Saudi targets in the past, claimed responsibility.

Safe bets

After the heightened geopolitical risk in the Middle East led to pullback in global equities, oil and gold prices rose at the end of the week. Brent crude rose to $68.60 a barrel, its highest level since mid-September, and gold, a haven for investors in rocky markets, almost reached a six-year high.

Gold rose nearly 1.7 per cent to a four-month high, while another alternative, Bitcoin, was up nearly 5 per cent. A further escalation in geopolitical tensions could provide additional short-term upside to oil and gold prices, analysts at UBS wrote in a client note. “Like we saw in 2019, the impact of risk events themselves on oil prices can be fairly short-lived if markets do not assess any substantial change to physical flows,” said Edward Bell, commodity analyst at Emirates NBD.

“Taking the attacks on Aramco’s Abqaiq facilities as a guide, a sharp move higher in spot prices unwound relatively quickly as the market assessed the overall impact on production and considered ample sources of alternative supplies.”

A more serious escalation in the Middle East would have a broader economic and financial market impact through sharply higher crude oil prices, UBS analysts said. Oil futures have gained for eight of the last nine weeks, bolstered by optimism that the China-US trade war would come to an end.

“While neither the US nor Iran wish for an escalation in tensions, no one knows if, when, and how Iran will respond”, UBS analysts added. “Considering these risks, markets have added a risk premium on fears tensions could escalate.”

Analysts also warned of markets diving deeper into the red if the situation further escalate between the countries or among its neighbours or trading partners. “Unlike attacks between May and September 2019, given the willingness of the US to strike such a high-level Iranian target, the UAE and Saudi Arabia are more likely to be emboldened to respond against Iran if they are attacked, raising the risk of escalation and full-scale confrontation,” said Firas Modad, Middle East Director at IHS Markit.