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Perspective: Morning Commentary for September 14

By: Mike Castle, Market Intelligence - Fertilizer Analyst

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September 14 – The week is set to kick off with stocks lower and oil higher following fresh deterioration in the Middle East, with the timing of the fresh rise in energy prices supporting the case of the hawks prior to the Fed’s September meeting that begins tomorrow. CME’s FedWatch now shows over 88% odds of a 25-basis point hike at this week’s meeting, with one more hike being priced in by year’s end. It’s a very light day of economic data, putting more market focus on the weekend’s notable geopolitical developments. The VIX matched last Thursday’s month-plus high at 18.17 overnight; it is now off its high as it trades near 17.6, but it’s worth noting that is up 11% from Friday’s close, reflecting these elevated concerns. The dollar is firming in response to these expectations of a  more hawkish Fed, up 0.5% on the day to trade back above 99.6 for the first time in nearly two weeks. Treasuries are quietly mixed, largely remaining at or near multi-year highs as 2-year yields trade at 4.643%, 10-year yields at 4.979%, and 30-year yields at 5.359%. Nearby WTI is trading at a nearly four-month high around $104.30 at the time of writing, while nearby Brent is up 4.7% on the day to trade at $109.50. The ags traded mixed in the overnights but are mostly looking at small gains to kick off the week after an ugly Friday selloff following the release of the September WASDE.

Monday’s planned Iran-Gulf meeting in Oman has been postponed indefinitely, with Omani Foreign Minister Bad Albusaidi announcing the decision on Sunday after a lack of consensus between Gulf states. Omani officials expressed expectations of the meeting still taking place at a later date, but nothing has yet been announced as of writing.  The U.S.–Iran conflict did not see another major confirmed exchange of direct strikes over the weekend, representing a modest cooling from last week’s escalation. However, an Iranian vessel was struck near Qeshm Island on Sunday under still-unclear circumstances, while tensions around U.S. protection of Hormuz shipping remain elevated. The pause therefore looks more like a lull than a meaningful de-escalation.

The more notable escalation of the weekend was on the other side of the Arabian Peninsula, with the Iran-backed Houthis continuing to make rapid gains on the ground in Yemen. The Houthis now effectively control Yemen’s entire Red Sea coastline, including the mainland opposite Mayyun Island at the Bab al-Mandeb chokepoint, after making a serious breakthrough late last week. Additionally, they have reportedly seized the Hanish Islands, tightening their grip on the northern entrance of the Strait. While control on the ground does not automatically mean control of the Strait, it does give the Houthis a significant strategic advantage in targeting vessels through the chokepoint, further threatening the flow of commodities.

Saudi Arabia is most exposed here. To make matters worse, the Saudi Ministry of Energy confirmed that its East-West pipeline has been shut down following damage from multiple drone strikes across two regions, with the most serious known damage on a pumping facility southeast of Medina. Satellite imagery shows substantial fire damage at the site, while Saudi Arabia has not provided an official repair estimate as of the time of writing. Industry assessments suggest complete repairs could take several weeks, potentially as long as six weeks, although partial flows may be restored considerably sooner if Aramco can isolate or bypass the damaged pumping infrastructure. Although flows through the Strait of Hormuz are reportedly increasing, they remain well below pre-war levels, making Saudi Arabia’s Red Sea export route that much more important. If the East-West Pipeline is restored but the Houthis effectively deny Saudi shipping access through the Bab al-Mandeb Strait, crude moving to Yanbu would be left primarily with a northern route through the Suez and into the Mediterranean. European shipments would therefore not necessarily be at risk, but cargoes destined for Asian markets would face a dramatically longer voyage around the Cape of Good Hope.

I’ll avoid diving too deeply into Yemen’s internal politics to prevent overcomplication, but another development worth watching is renewed friction involving former STC-aligned factions, historically backed by the U.A.E., and Saudi-backed Yemeni government forces. After more than a decade of civil war, Yemen remains an extraordinarily fractured state. Despite being pitted against one another in the conflict, Saudi Arabia and the U.A.E. have shared a common interest in containing the Houthis but increasingly backed competing factions and political outcomes in southern Yemen—a divide Iran is clearly attempting to exploit. Saudi-backed forces reversed the STC’s territorial gains in January, after which the STC effectively collapsed, with many of the remaining forces brought into the Saudi fold to defend against the Houthis. If significant elements of those forces now turn against the Saudi-backed government on a larger scale, the Saudi’s ability to organize a cohesive counteroffensive and regain control around the Bab al-Mandeb becomes even more difficult, keeping the risk of disrupted commodity flows through the Red Sea elevated.

Why has the Saudi response been so limited thus far? This is the primary question I’m left with after the rapid developments of the last week. My assumption is they fear a more significant ground escalation could trigger even heavier strikes on their critical energy infrastructure, with reports of dwindling interceptor supplies likely playing a major role. The U.S. has reportedly refused to resume strikes on the Houthis despite multiple Saudi requests, opting to instead focus on intelligence and advisory support. Similarly, the Saudis have refused to commit anything other than air support to Yemeni government forces. It’s difficult to see the government forces retaking Yemen’s coastal territory and strategic islands with air support alone. Before getting too concerned that all is lost, however, I want to point out that rapid territorial swings have been a common feature in this conflict in recent years. The Houthis current rapid gains are reminiscent of gains made by the STC last December, before a Saudi-backed counteroffensive ultimately reversed these gains just as quickly, leading to the effective dissolution of the STC. That leaves Riyadh in a difficult position: commit more fully and risk heavy losses on the front lines along with potentially greater attacks on infrastructure at home, or maintain a more measured, air-based response and risk a prolonged disruption around the Bab al-Mandeb. There are clearly no easy answers, and that uncertainty is helping the market price additional geopolitical risk to start the week.

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