The FTSE 100 surged on Monday, propelled by a dramatic collapse in oil prices back to pre-crisis levels, as traders priced in a potential resolution to the Strait of Hormuz standoff. London's blue-chip index climbed 1.8 per cent by midday, shrugging off the geopolitical tension that had sent crude soaring just weeks ago. Brent crude tumbled below $60 a barrel, a level not seen since before the latest escalation, as whispers of a diplomatic breakthrough in the Persian Gulf triggered a wave of profit-taking and short-selling in energy stocks.
For the City, this is a classic risk-on rotation. The oil price plunge is a double-edged sword: it slashes input costs for airlines and shipping firms, pushing shares in British Airways owner IAG up 4 per cent, while hammering the likes of BP and Shell, which shed 2 per cent. But the broader market is cheering the deflationary impulse. The FTSE 100's heavy weighting in international earners means a weaker dollar and lower energy costs are a recipe for margin expansion. Investors are betting the Bank of England will have more room to hold rates steady if inflation expectations ease further.
Yet the cynic in me smells a trap. The Strait of Hormuz remains a hair trigger. Iran's Revolutionary Guard still has speedboats and mines, and any miscalculation could send Brent back to $100 overnight. This rally is built on a peace premium that could evaporate with a single drone strike. Meanwhile, gilt yields are barely moving, with the 10-year yield stuck at 1.2 per cent, suggesting the bond market isn't buying the risk-on story. The capital flight from emerging markets into the dollar is still there, lurking beneath the surface. Remember, the last time oil crashed this fast, it was a signal of global demand destruction, not a geopolitical buy signal.
Fiscal responsibility? Forget it. The government is still borrowing at wartime levels, and the Chancellor's latest budget splurge is already pricing in this oil windfall. If crude stays low, the Treasury's coffers get a short-term boost from lower petrol prices, but the long-term hit to North Sea revenues and the energy transition tax base will sting. The market is focusing on the near-term sugar rush, but the hangover will come when the Strait of Hormuz crisis either ignites or fades into the next supply glut.
Central bank policy remains the wild card. The Fed's pivot and the ECB's dovish lean are driving the risk rally, but the Bank of England is stuck in a corner. With Brexit uncertainty still hanging over the economy, the MPC is unlikely to move. Lower oil gives them cover to stay on hold, but if growth picks up as oil drops, the hawks will start chirping about core inflation expectations. For now, the market is pricing in a cut, but that's a bet against the Bank's own forecasts.
Volatility is the only constant. The VIX-equivalent in London is elevated, and the oil options skew is screaming for protection. Any investor sitting on this rally without hedges is playing with fire. The smart money is taking profits on the FTSE and piling into inflation-linked gilts as a barbell trade. If the Strait of Hormuz crisis resolves peacefully, we get a deflationary boom. If not, we get stagflation. Either way, the bottom line is: don't chase this rally blindly.
