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Horatius Geopolitical Briefing: Is The Middle East on the Brink?

A number of you have asked about the situation in Iran. Please see our initial thoughts. More intelligence is still coming in but these are our initial thoughts having balanced a number of different views.  The killing of Maj Gen Qassem Soleimani by a US drone strike brings a new level of tension to the Middle East. Soleimani was the head of the Quds Force, Iran’s principal weapon in its fight against Israel and the US. The Quds Force arms, trains and directs proxy militias and terrorist groups from Gaza to Afghanistan, and mounts its own terrorist operations on every continent bar Antarctica. Soleimani directed all of these operations. He was therefore the man who made possible Tehran’s creation of the outsize regional influence and capacity for mayhem that buffers it against an unfriendly world. This made him the principal guardian of the Islamic Revolution, close to the Supreme Leader Grand Ayatollah Ali Khamenei, and perhaps the second most powerful man in Iran. Yet he was also indispensable. In the words of a former senior official from the Obama-era US Department of Defense, ‘[f]rom a military and diplomatic perspective, Soleimani was Iran’s David Petraeus and Stan McChrystal and Brett McGurk all rolled into one.’  This comparison is telling. Petraeus devised and directed the ‘surge’ that turned the tide in Iraq in 2006-9. McChrystal devised and directed the special operations campaign that crippled Al-Qaida in Iraq and made possible the ‘surge’’s success. And McGurk was the US’s key diplomat in the region for over a decade, building support behind the Iraqi government, knocking its fractious elements’ heads together to get them to co-operate, and then building and maintaining the diplomatic and political coalition that defeated ISIS – a coalition that included states as mutually hostile as Turkey, Saudi Arabia, Qatar and (covertly) Israel. All three were known as hugely bright consummate professionals with an unusual ability to think strategically. Soleimani was Iran’s ability to project power effectively. And Tehran has no one person to take his place. Which means payback will be significant. Tehran claims this is an act of war, conveniently forgetting that Soleimani and his Quds force have been engaged in a war against the US for decades – a war in which Iranians have killed US personnel, but with retaliation being visited on Tehran’s proxies. If Iran has yet to respond, it is in part because it will be stunned; Soleimani had long been thought to be untouchable. Tehran will also be nonplussed; the person needed to tell the leadership what to do has himself been killed. Yet the regime will also be thinking hard. For it is fully aware that it’s campaign of coercion against the US’s ‘maximum pressure’ policy has now entered a different level – one which makes open hostilities with the US technically much more likely.  This will not have been the intention.  The killing and wounding of US personnel in Iraq by a proxy militia, Kata’ib Hizbollah (KH), in December was a wilful crossing of a US red line established in April 2019, aimed at seeing how the US responded. (Given that President Donald Trump has persistently rowed back from using force against Tehran, the regime may even have believed its own rhetoric, that he is a particularly weak leader of a weak amoral state, and reckoned on impunity.) The US duly followed the playbook of decades past, hitting back at KH – not Iran – killing much of its senior leadership; proxy militias then mounted violent but still largely theatrical ‘protests’ against the US embassy in Baghdad in a move almost certainly intended to end this round of tit-for-tat. Instead the US upped the ante, killing both Soleimani and KH’s leader (travelling together in a convoy from Baghdad Airport). Suddenly this is a fight between the US and Iran, not just their proxies. And this introduces a level of danger that Tehran will not have intended. What will happen next?  The US move does not seem to have been part of any over-arching strategy; the opportunity presented itself (the original target may even have been KH’s leader), and it was taken. The White House says the strike was intended to avert planned Iranian attacks on US targets, and deter further ones; it appears to see it as an individual act rather than the first step in a wider campaign. The difficulty, of course, is that while Iran will undoubtedly realise that the costs of its activities will now have increased substantially; and could in theory see Soleimani’s killing as a minor escalation (he was after all fair game, killed in Iraq – from which he is banned under UN Security Council resolutions – and while alongside someone who’d just killed a US citizen); in reality it will have no choice but to respond by launching exactly the type of attacks Soleimani’s death is supposed to stop.  What will this mean to the region?  Neither side wants open hostilities, but they have become more likely – more as a function of misreading moves than a policy choice. If Iran attacks US interests then expect US airstrikes or drone strikes in return. Yet any hostilities are highly unlikely to result in all-out war, if only because Trump is utterly, viscerally opposed to one. Instead Iranian actions and US reactions are likely to occur along the spectrum seen in the 1980s, where attacks on US citizens or facilities were met with retaliatory deniable assassinations and strikes on shipping or air defence networks.  The kind of regionally destabilising full-scale war which worries markets and investors alike is highly improbable.  Further Iranian pressure on regional commercial interests in or linked to states aligned with the US will almost certainly increase. Yet Iran will have fewer levers in this campaign. In part this is because of the loss of Soleimani. But it is also because Iran’s regional proxies are now on the back foot. Lebanon’s Hizbollah and Iraq’s Iranian-backed militias were already under huge domestic political pressure as mass protests against Iranian influence took root; attempts to turn these states into proxy battlefields will further undermine them, particularly as the US will be providing much more robust support to the governments trying to keep these militias in check. Couple this with a much more forward US presence in the Persian Gulf – heightened readiness will mean much less tolerance for Iranian adventurism – and Iran will find it harder to wage the kind of campaign seen during most of 2019. On the downside, its efforts to wage that campaign will be much more clumsy and ill-judged with Soleimani out of the way. Markets, of course, will get the jitters as soon as Iran responds. The imagined end-state of any kind of hostilities is the kind of outright war that is almost certainly off the table, ensuring over-reaction to terrorist attacks or exchanges of fire, followed by an equivalent over-reaction once it is clear the violence will not lead to Armageddon.  This is likely to last for much of the next few months, in large part because the baseline already identified – Iran must push back against ‘maximum pressure’ with the tools it’s got, while the US won’t change course – will still hold even if tension between both sides is heightened. These jitters will almost certainly resolve themselves into a sense that the region faces heightened tension at least until January 2021 (when in theory a new US administration might change course) – a sense that will be reflected episodically in market sentiment, either in conjunction with wider geopolitical unease, or as a result of apparent threats to key sectors or commodities. As ever, the key for a fund like Horatius will be to understand when market sentiment is misplaced. And it appears as though the next few months will provide plenty of opportunities for just that.  Geopolitical tensions aside, we wish you all a very happy New Year. All best wishes Dominic and the Horatius team. Dominic Armstrong CEO HORATIUS CAPITAL Mobile: +44 (0) 7977 928 898 53 Davies Street  London W1K 5JH

We are delighted to announce that Horatius is the winner of the HFM European Emerging  Manager 2019 – Fixed Income Under $100m Award. Horatius Capital Limited is an Appointed Representative of Privium Fund Management (UK) Limited which is Authorised and Regulated by the Financial Conduct Authority. Horatius Capital Limited is a limited company registered in England and Wales with registered number 10436077. Our registered office is at 22 Chancery Lane, London, United Kingdom, WC2A 1LS.

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