A demonstrator holds the picture of Qassem Soleimani during a protest against the assassination of the Iranian Major-General Qassem Soleimani, head of the elite Quds Force, and Iraqi militia commander Abu Mahdi al-Muhandis who were killed in an air strike in Baghdad airport, in Tehran, Iran January 3, 2020. WANA (West Asia News Agency)/Nazanin Tabatabaee via REUTERS ATTENTION EDITORS - THIS IMAGE HAS BEEN SUPPLIED BY A THIRD PARTY.
The death of Qassem Soleimani prompted selling on global markets but investors largely kept their nerve © VIA REUTERS

Stock markets stumbled around the world after a US air strike in Baghdad killed a senior Iranian official in the first geopolitical shock of the year, but analysts and investors said the pullback marked a pause after a string of record-breaking runs rather than a serious shift to fear of a broader Middle East conflict.

In the US, the S&P 500 stock index dropped as much as 1 per cent from a new all-time peak set on Thursday, while the FTSE All-World index and Europe’s Stoxx 600 suffered a more modest blow.

Government bonds jumped, gold carved out its biggest rally since October, and oil prices climbed by 2.7 per cent, all indicating a new injection of risk into what have been benign market conditions. But the scale of the shake-out eased as the day progressed and signs of extreme market stress after the death of Qassem Soleimani were lacking.

“In the stock market, the killing of Soleimani seems like a convenient excuse to take some profits in an asset class that has had a great run, but few love at recent valuations,” said David Lafferty, chief market strategist at Natixis Investment Managers. “The question now is will the rally be temporary or will safe haven assets remain elevated.”

Line chart of Spot gold price in $ showing Gold surges after US airstrike

The attack on the head of the Iranian Revolutionary Guards’ overseas forces came days after the US embassy in Iraq was stormed by Iran-backed militia and marked a dramatic escalation in tension in the region. Iran has vowed to retaliate.

In severe circumstances, that sort of retaliation could fire up oil prices to the point where they posed a serious risk to US consumers and the US economy, undermining the support for the country’s stocks and potentially even forcing the Federal Reserve to cut interest rates in response. But that outcome has not been priced in.

“Heading into the beginning of the year, markets had done extraordinarily well, but sentiment was starting to get really frothy,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “That suggests there is more vulnerability if there is a catalyst, and now we have it.”

The sell-off in US stocks came after a strong performance in 2019 that marked the best year since 2013. Friday morning’s selling hit financial and healthcare stocks the hardest, while energy stocks, buoyed by the higher price for oil, gained 0.3 per cent.

For Greg Peters, a senior portfolio manager at PGIM Fixed Income, the attack serves as “a stark reminder that risks are still out there”. He said he still sees sustained value in Treasuries and in currencies considered to be havens, such as the yen and the Swiss franc. “This is yet another dagger in the heart of global trade and confidence,” he said.

Friday’s support for government bonds and stock sell-off accelerated after the release of data showing that US manufacturing activity had shrunk to its lowest level in more than a decade.

“A lot of what has caused the manufacturing recession and weakness in business investment and corporate animal spirits has obviously been the trade war,” said Ms Sonders. “I can’t imagine that this doesn’t add to the uncertainty.”

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