Restarting the Iran War Trade Didn’t Stick. On to the Fed.

Gold refused to break and the dollar couldn’t hold a rally amid spiking oil prices. Still, the markets are convinced that a Fed rate hike is due this week, and several more soon after. Will Warsh and company deliver?

• Saudi Arabia’s East-West pipeline was closed by drone attacks, tightening a chokepoint problem that was already severe
• Gold attempted a breakdown and failed, the dollar attempted a breakout and failed, and Bitcoin rallied almost 3%
• Traders now lean toward 50 basis points of tightening before year-end, a bar the Fed chair may struggle to clear

The war trade received about as clean a setup as it could ask for, and it could not make much of it. Nearly every move that followed from what appeared to be a genuine oil supply shock ran intraday and then unwound.

The threat looked real. Saudi Arabia's East-West pipeline was shut after drone attacks reportedly launched from Iraq, where Iran retains sway over some proxy militias. That pipeline has been a key outlet to move Saudi crude to the world markets bypassing the troubled Strait of Hormuz. Closing it sharpens a chokepoint problem that was already acute.

Meanwhile, Houthi forces have been massing around Bab el-Mandeb, another critical node away from Hormuz to ship out of the Persian Gulf. On top of all that, a meeting at which Iran was to present other Gulf producers with a plan for reopening Hormuz was called off. Crude spiked toward $105/bbl on the WTI benchmark before pulling back on reports that President Trump is open, conceptually, to talks with Tehran.

Nothing stuck the landing

In the “war trade” logic defined at the start of the conflict in late February, that potent mixture might have been expected have delivered higher oil, higher yields, a firmer dollar, and a weaker gold price. It did, but only for a few hours.

Gold made a determined attempt at a breakdown and failed to hold it, recovering as crude retreated and closing back above the support that has underpinned it for weeks. The dollar staged an impressive rally on the same headlines and yet not clear the bounds of its recent ranges against the major currencies. Bitcoin climbed over 2%. Treasury bond yields probed higher but move refused to stick.

Markets have priced the Fed into a corner

All eyes now turn to the looming policy announcement from the Federal Reserve. Futures markets put the probability of a 25-basis-point (bps) rate increase at 92.3%. That is remarkable conviction. A week ago the odds sat closer to 60/40, and a month ago markets favored no change at all by about 65/35.

Last week’s big-splash inflation data arrived broadly as expected. With event risk thus behind them, traders seemed to treat the data as a kind of “green light” to test if Fed Chair Warsh means business.

The path beyond this week appears aggressive. By December, the cumulative probability of that second hike reaches over 90%. Another hike is then penciled in by March, and the odds on one more after that before 2027 is out look better than even. Warsh has loudly asked markets to stop reading the Fed and instead guide him through prices. This is the signal they have sent.

What will the Fed now do with it? To validate what markets are already pricing in, officials probably need to come up a sharply hawkish revision of their Summary of Economic Projections (SEP). A fierce Mr. Warsh must then reinforce as much at the press conference following the rate decision. That seems like a high bar for Federal Open Market Committee (FOMC) that thought rates would peak this year and a Chair who delights in avoiding “forward guidance”.

If policymakers fall short, the so-called “debasement trade” will find a fresh catalyst. That translates into support for gold and Bitcoin alongside pressure on the dollar. Today those trades survived their stiffest test in weeks by narrowest of margins. A hike that arrives without strident hawkish signaling to match would hand them a potent lifeline.

Ilya Spivak, tastylive Head of Global Macro, has over 15 years of experience in trading strategy. 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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