It’s looking like the Israel/Iran/U.S. conflict is going to turn out to be a big nothing. This is pretty clear looking at the behavior of the markets over the past week or two. Risk assets had turned modestly risk-off in the lead-up to last weekend. The dollar strengthened and gold rallied in a flight to safety move. Even after the U.S. attack on Iran’s nuclear facility, crude prices moved little and stocks actually opened higher in the session. Once Iran executed its very calculated and very telegraphed response, the markets turned risk-on again.
Investors clearly believed that this would be a short-term disruption that wouldn’t have any lasting impact on the geopolitical picture. They’re probably right. Iran looks like it’s on its own in this conflict and that’s likely to lead to them backing down pretty quickly and easing a lot of tension in the region. All sides have effectively confirmed that a ceasefire is in place, which pretty much brings this situation to an end. In a year full of starts & stops on multiple fronts, this has been one of the more impressive.
The focus this week probably then turns to the Fed. While the central bank’s Dot Plot indicated two rate cuts yet this year, which is what the futures market is also pricing in, it feels like this is far from a done deal. If we’re inferring from some of the recent speeches and rhetoric, it sounds like there are multiple members still in no hurry to begin easing. Powell’s congressional testimony is unlikely to reveal any new information, but we could get some kind of indication or response to Trump’s latest personal attacks and calls to reduce the Fed Funds rate by 200 basis points or more (which would almost certainly rock the markets). Maybe the Fed cuts in the name of normalization, but I’m not sure current services and rent inflation rates will let them do it.
As a result of this week’s Middle East blip, gold is retreating pretty quickly, but Treasuries are looking better. Perhaps there’s some momentum building for rate cuts as soon as next month, but I think this could be setting up for some disappointment. The market seems to think inflation is under control. It might be at a high level, but with another tariff shock looming in the background and the aforementioned services and rent inflation rates still way above target, the job doesn’t look like it’s done.
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