“Please do not retaliate”.
That’s the plea the world sent Tehran on Monday, as mourners thronged the streets to pay respects to slain general Qassem Soleimani. The outpouring of grief has united a nation which, just weeks ago, was deeply divided amid the worst anti-government protests in decades.
Thanks in no small part to big-cap tech, US equities managed to pare early losses on the way to closing higher on above-average volume. High beta stocks narrowly outperformed their low vol. counterparts to start the week after underperforming by the largest margin in two months on Friday amid the risk-off trade.
The yen pulled back from three-month highs and gold lost a bit of its luster after rising to the highest in more than six years. 10-year US yields ended near the cheapest levels of the day as risk aversion receded.
The narrative, generally speaking, is that as long as any military conflict doesn’t dent the outlook for global growth, there’s no readily discernible reason for risk assets to overreact.
That’s all fine and good (and, in many respects, rational), but in case it’s somehow not clear enough, these are perilous waters – and we don’t mean that in any kind of generic sense. Last week, Donald Trump changed the course of history. Perhaps for the better. Perhaps not. Nobody knows.
What we do know is that exhortations to restraint notwithstanding, Iran will almost surely strike US interests, seek to curtail key shipping lanes or otherwise lash out via its proxies, or directly, in the days and weeks ahead.
Meanwhile, the Iraqi parliament has voted to expel US troops in what, for now, is a non-binding resolution. Following reports of a letter circulated among military officials suggesting the US was preparing to depart, Mark Esper on Monday suggested America might actually refuse to leave. “There is no decision to leave nor did we issue any plans to leave or prepare to leave”, he remarked.
To be absolutely clear, if the Iraqi government formally rescinds the invitation for US troops to operate in the country and Trump refuses to comply (as he suggested he might), the US will be an occupying force, and it will not matter that the Kurds and the Sunnis would prefer the Americans stay. It’s also unclear how the US would operate an embassy while in open defiance of an official order to cease and desist from military operations.
Bear in mind (no pun intended) that the late-2019 melt-up pushed stocks into overbought territory. So, it would hardly represent an “overreaction” if equities were to pull back. BofA said Monday the S&P could well drop 7% given the gravity of what happened in Baghdad last week.
From an economic perspective, the bank notes the obvious, which is that if oil prices were to stay high, there’s a risk of stagflation, “plus the impact on corporate and consumer sentiment [and] spending”.
Of course, central banks would welcome a bit of inflation, and would be more than willing to “look through” any uptick catalyzed by a spike in crude. So there’s no reason to fret about any inflation-related hawkishness. If anything, spiraling geopolitical tensions would prompt more dovishness.
In a quick post on Monday, Bloomberg’s Ye Xie noted that “you might not realize it but gasoline prices rose 15% in the US last year [and] that didn’t stop people from spending, as personal consumer expenditures rose 3.9%”.
A good point, to be sure, but the thing about gas prices is that people tend not to notice as long as the spike isn’t dramatic. When it is, the psychological impact can be commensurately adverse. And let’s not forget that an oil shock in an election year wouldn’t be the best thing for Trump.
“Geopolitical concerns trump macroeconomic developments, but the markets can’t be accused of over-reacting so far”, SocGen’s Kit Juckes said Monday. “If there is a significant escalation, we’ll get reactions in the real world and in markets but in the meantime, oil prices are likely to remain relatively elevated for longer than wider risk aversion can persist, in the absence of new developments”.
“In the absence of new developments” being the key phrase there.
I suppose we should all be thankful that Monday came and went without another escalation, but then again, the entire Iranian leadership (indeed, the entire Iranian people) were preoccupied with laying Soleimani to rest. The general will be buried on Tuesday. After that, it’s presumably “game on”.