Analysts anticipate Iranian response, but don't expect all-out conflict

A US drone strike killed the Iranian military commander in charge of overseas operations, prompting a shift towards safe havens as investors waited for Tehran's response.

Qassem Soleimani was the head of the Iranian Revolutionary Guard's Quds Force, the special branch of Iran's security apparatus that The New Yorker described in a recent article as a combination of the country's equivalent to the US Central Intelligence Agency and American special forces.

During more than 20 years, Soleimani had directed Iranian military operations overseas, including in Lebanon, Iraq and Syria and ordered actions that had cost the lives of hundreds of Americans.

The US Secretary of State, Michael Pompeo, said the action was meant to prevent further attacks that Soleimani was plotting.

"Although the US administration and notably President Trump have appeared to be risk averse to military conflict in the Middle East, the impeachment procedure, his declining popularity, and the upcoming elections are factors that may affect that balance of risks," said analysts at Rabobank.

Other analysts believed the risk of an all-out conflict was less, but conceded that it did exist.

Making that point, Pantheon Macroeconomics's Ian Shepherdson told clients: "Iran's military reach via proxies across the Middle East gives the leadership plenty of options, including retaliatory assassination attempts, kidnappings, bombings of U.S. government facilities, and attacks on shipping and other privately-owned U.S. entities.

"Iran might also seek to draw Israel into a conflict via Hezbollah in Lebanon. We can't rule out some sort of grand-scale attack, but an array of smaller-scale activity is our core bet," Shepherdson added.

"Iran will respond; the how and when is uncertain but full-scale war is unlikely. [...] To repeat: Iran will respond."

For his part, IG's Chris Beauchamp chimed-in saying: "While escalation is possible, it is more likely that the US-Iranian crisis of January 2020 will pass with little more than a few days of tension."

Caroline Bain at Capital Economics was of a similar view, telling clients that : "over the coming weeks, the fall-out from last night’s assassination will become clearer. Both Iran and the US have shown a reluctance in the past to embark on outright conflict, but this does not preclude a period of heightened tensions and elevated oil prices.

"But irrespective of geopolitical factors, we think that the oil price will end the year higher based on supportive supply and demand fundamentals."

And what might the implications be for stocks if the situation did escalate very significantly?

According to analysts at ING: "were events in the Middle East to escalate severely, overweight positioning in risk assets could easily trigger a 7-10% correction in global equity markets."