What can traders expect if Middle East conflict escalates?

Gold and the US Dollar have been surging!

Demand for these 2 traditional safe havens have been fuelled by, among other factors, rising fears of escalating tensions in the Middle East!

What is a safe haven?

A safe haven is an asset that helps investors preserve their wealth when there's greater fear or uncertainty across global financial markets.

"Popular" safe havens include the US dollar, gold, the Japanese Yen, and the Swiss Franc.

Which safe haven could rise the highest if Israel retaliates against Iran?

The US dollar and gold are perhaps likelier to attract more safe haven demand, rather than CHF (Swiss Franc) or JPY (Japanese Yen) this time around.

First, consider how gold spiked higher in recent history, following:

• the Covid-19 pandemic
   
• Russia's invasion of Ukraine

More recently, gold has been on a seemingly unrelenting pursuit of new record highs!

In recent months, gold's surge has been fuelled by a confluence of bullish factors:

• starting with bets for Fed rate cuts in 2024 (which have now been pushed back)
   
• along with a buying spree by the People's Bank of China (China's central bank) and also Chinese retail investors
   
• all amid the ongoing geopolitical fears

If this historical pattern plays out once more ...

Gold could be spurred on to chase higher peaks if market fears escalate even further!

Similarly, the US dollar stands to benefit from a flight to safe havens.

This is likely due to:

• the "exceptionalism" demonstrated by the US economy (investors tend to park their money in the stronger economy when times are fearful/uncertain)
   
• and also the higher yields currently offered by US Treasuries (US government bonds, another much sought-after safe haven asset).

Already, the USDInd (US Dollar index) is trading around its highest levels since early-November; a 5-month high!

NOTE: USDInd tracks the US dollar's performance against a "basket" of 6 different currencies, namely the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc.

However, CHF and JPY could lose out this time around.

Note that their respective central banks have more-dovish (SNB) / less-hawkish (BoJ) policy stances than markets expect:

• Swiss National Bank (SNB) could cut its rates again in June, having surprised markets with a rate cut back in March 2024.
   
• Bank of Japan (BoJ) could hike its rates by another 20 basis points before 2024 is over.
  However, a 0.2 percentage point hike isn't likely to narrow the gap between 10-year government bond yields between the 2 economies.
   

US 10-year yields now stand at over 4.6% while Japan's 10-year yields only offer 0.86%.

Besides safe haven allure, markets also tend to prefer the currency that offers the higher yields.

Hence, CHF and JPY may be laggards come a next wave of safe haven demand, already being among the worst-performing G10 currencies against the US dollar so far this year.