With the war in Iran about to enter its fifth week, global investors are dashing for cash, selling shares, bonds, gold and just about anything else they could get their hands on in a scramble to lower risk.
In a two-day selloff at the end of last week, the US sharemarket lost 3.6 per cent of its value – the worst two-day performance since Donald Trump’s “Liberation Day” tariffs were unveiled on April 2 last year.
That market is now down about 7.7 per cent since the start of the war. Global stocks, measured by the MSCI All Country World Index, are down 9 per cent and the Australian market about 7.4 per cent.
The tech-oriented Nasdaq index, which tumbled 4.3 per cent on Thursday and Friday, has fallen more than 10 per cent since the onset of the war, so technically is in “correction” territory.
There’s also been a similar selloff in the US bond market, where yields (which have an inverse relationship with bond prices) have spiked since the conflict began. The two-year yield was 63 basis points above pre-war levels on Friday, the 10-year yield was 49 basis points higher and the 30-year yield 36 basis points higher.
Even gold, which was on a record-shattering tear earlier in the year, has been dumped for cash, with the price down about 15 per cent from the start of the US-Israeli assault.
The dumping of investments for cash indicates that Trump’s current strategy for calming the market is losing – may have lost – its effectiveness.
Last week markets rebounded after, having given Iran a 48-hour ultimatum before he threatened to blow up Iranian power plants, he extended the deadline to five days and talked about great progress in negotiations – negotiations that the Iranians subsequently denied had taken place. On Thursday, he extended that grace period to 10 days.
It’s obvious that Trump is looking for an exit – he wants to “chicken out” – but can’t find one that doesn’t look like an American and personal humiliation.
The market was betting on another “TACO” (Trump Always Chickens Out) moment, but Trump’s continuing declarations of victory and threats to unleash hell if the Iranians don’t surrender unconditionally aren’t yet providing one.
Trump, who first declared victory in Iran nearly three weeks ago (and blames Iran for not understanding that it has been defeated!) is floundering.
The Strait of Hormuz effectively remain closed, although the Iranians are allowing some oil tankers from countries with which is has friendly relations passage through the strait, while extracting some yuan-denominated tolls in the process.
The world is experiencing massively increased oil and gasoline prices, with a growing threat of actual supply shortages, along with similar price impacts and supply issues for diesel, jet fuel, fertilisers, other oil derivatives and aluminium.
The rise in the oil price from around $US70 a barrel to $US115 a barrel, with consequent increases in petrol prices – the average US price of petrol has jumped from $US2.98 a gallon to $US3.98 and for diesel from $US3.76 a gallon to $US5.40 – is leading to fears of supply chain shocks, inflation and, if not recession, then stagflation.
It’s not just the US impacted. The US economy was slowing and the jobs market stalling even before the war, but at least it has its own supplies of oil and gas. The price might have risen, but at least it has its own source of fuels.
Europe, however, was experiencing even lower growth and now faces its fuel import-dependent economies face another energy crisis akin to that which occurred when Russia invaded Ukraine, but with less fiscal flexibility to respond to it.
Asian economies are even more exposed to the steep increase in prices and reduced availability of oil and gas.
The abrupt change in sentiment in the US markets late last week appears to have been due to a belated concern that Trump and his cabinet are making things up on the fly and, indeed, might be just making things up (like the status of the negotiations) to create an impression that they are in control of developments.
The military campaign has been well-executed, but the administration planned poorly beyond that, miscalculated what should have been the obvious Iranian responses to the assault – the Iranians had telegraphed what they would do if attacked – and seem to have no idea of how to extricate themselves, other than making threats that the Iranians mock.
Now the US is assembling ground troops in the Middle East – it has added about 10,000 marines and airborne troops to its existing forces in recent days – which could presage a risky and unpredictable escalation in hostilities that Iran might, as it has threatened, respond to with large-scale destruction of the US regional allies’ energy and water infrastructure.
Trump is highly sensitive to financial markets. He usually does chicken out when the markets respond badly to his plans.
Deutsche Bank has even created a Trump pressure index, which measures changes in his approval ratings, the share and bond markets’ performances and expectations of inflation to try to predict his next TACO moment. The index has been higher recently than it was in the aftermath of Trump’s Liberation Day tariffs.
Bloomberg surveys, published last week, of consumer sentiment and inflation expectations that showed sentiment falling and inflation expectations rising fit with what is now developing within the financial markets.
The bond market’s expectation before the war was that there would be at least two US Federal Reserve Board rate cuts this year, That has now fallen to one cut, in line with the majority of Fed officials at this month’s rate-setting meeting, late in the year. Priced into the markets, as a more than 30 per cent probability, is a rate rise.
The markets are starting to look very much as they did in the latter months of 2022, when the pandemic’s supply chain disruption caused inflation rates to soar and central banks responded with interest rate hikes.
If the conflict in the Middle East and the flow of oil and oil derivatives from the region is choked for a prolonged period, it will impact inflation rates around the world, lead to higher interest rates and lower growth rates with the pandemic’s legacy of hefty increases in government debt (exacerbated in the US by Trump’s profligacy) limiting governments’ abilities to respond.
It’s obvious that Trump is looking for an exit – he wants to “chicken out” – but can’t find one that doesn’t look like an American and personal humiliation.
Higher bond yields and interest rates and more cautious lenders in a more volatile and less expansionary environment would also raise the risk of a financial “event.”
There’s already some anxiety about the scale of investment and borrowing by the “hyperscalers” ploughing trillions of dollars into artificial intelligence in the hope of eventual, but uncertain, oversized returns and there’s also some nervousness about the state of private credit and private equity.
There’s also the impact of the ongoing US trade war on the rest of the world on global growth and confidence and, as those tariffs are a tax on US companies and consumers, on US inflation, employment and growth.
The last thing the US or the world needed was to add a lengthy war in the Middle East and severe disruption to global oil and oil derivative supply to Trump’s already-disruptive agendas.
The markets are now discounting Trump’s statements about the state of the war. Investors realise, for the war to end, it will take two to TACO and the Iranians don’t appear enthusiastic about co-operating.
No wonder investors are feeling queasy.
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Stephen Bartholomeusz is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.Connect via email.
