Iran War and Markets: A Trade Hiding in Plain Sight?
Iran War and Markets: A Trade Hiding in Plain Sight?
By:Ilya Spivak
Away from the jumpy price action in stocks and bonds amid the US-Iran war, a trade may be hiding in plain sight.
- Stocks and bonds struggle to rebound as Iran war fears persist
- The markets expect a forceful central bank response to inflation
- The US dollar may rise as traders rethink hawkish policy pivot
The hopeful mood on display across financial markets at the start of the trading week seems to have fizzled. US stock markets traded mostly weaker, though the small-cap Russell 2000 managed a narrow rise while the tech-tilted Nasdaq 100 and the catch-all S&P 500 finished the day in the red.
Treasury bonds turned lower right on cue, with the parallel rise in yields helping to arrest a slide in the US dollar. Up to that point, the markets appeared to be replaying the now-familiar “Iran war = inflation = higher rates” dynamic in play for most of the month.
Gold prices pointedly decoupled however, shrugging off early intraday losses to finish the session with modest gains. That snapped a nine-day losing streak, the longest since October 2023 and only the third such run in 30 years. Crude oil – the would-be vector for transmitting the impact of events in Iran into asset prices – was curiously noncommittal.
Markets think rate hikes are ahead as inflation jumps. Really?
On one hand, this echoes what price action has telegraphed since last week: an inflationary shock is now on autopilot, whatever oil prices do next in the near term. On the other, it beckons a closer look at where the markets have landed after all of the fast-and-furious repricing of expectations since the Iran war began.
A striking new vision of global monetary policy has appeared. Traders have abandoned hopes for rate cuts from the Federal Reserve this year. Meanwhile, the European Central Bank (ECB) is seen hiking rates by 50-75 basis points (bps), having been set for a year at standstill just three weeks ago.
Similar changes have appeared for most major central banks. Year-end policy expectations priced into futures markets for the Bank of Canada (BOC), the Reserve Bank of Australia (RBA), and the Bank of England (BOE) have swung in a more hawkish direction by 30bps, 50bps, and 125bps respectively.
At face value, this might feel like it makes sense. The markets’ response to the Iran war has focused on its inflationary risks. Central bankers would surely be reluctant to cut rates against such a backdrop, lest they allow backsliding on their efforts to bring prices to heel after the Covid-19 pandemic.
Is the US dollar too cheap?
That makes the pivot in the markets’ outlook for the Fed appear sensible, at least for now. However, rate hikes from the likes of the ECB and the BOE seem implausible after the March edition of purchasing managers index (PMI) data from S&P Global revealed a sharp slowdown in economic activity growth in both the Eurozone and the UK.
“Cost push” inflation is the kind that comes from a sudden rise in the cost of some key input for economic activity, like energy. “Demand pull” inflation is the sort that accompanies rapid economic growth, where the supply of goods and services is struggling to keep up with voracious spending.
Interest rate hikes are the textbook response to the latter problem, but the Iran war presents policymakers with the former one. Slamming the brakes on a fragile Eurozone economy with rate hikes may well trigger recession, and so the ECB is unlikely to do it. Today’s inflation risk may paralyze central banks rather than turn them hawkish.
The US dollar may find a potent reason to trade higher if the markets come to the same conclusion. The currency’s present level implies a policy outlook that puts it at a disadvantage of between 25bps and 100bps against its top counterparts. If those gaps narrow as markets rethink the feasibility of rate hikes, a tailwind for the greenback will emerge.
Ilya Spivak, tastylive head of global macro, has over 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak
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