Wednesday marked one of the more eye-popping reversals in recent memory across assets.
Fears that Iran’s retaliatory strikes against US bases in Iraq might trigger a war gave way to a palpable sense of relief when Donald Trump indicated he shared the view of experts and independent observers who, in the hours after the rocket attacks, described the IRGC’s actions as an attempt to preserve national pride (i.e., save face) following the assassination of Qassem Soleimani.
Iraq was notified ahead of time, and it’s entirely likely that the advance notice given to Baghdad was intended to be communicated to the US, allowing American troops to hunker down and minimizing the risk of casualties. There was also evidence that Iran deliberately avoided inflicting heavy damage on the bases.
Of course, it’s also possible that Tehran sees little else to gain in the near-term with the Iraqis now clearly predisposed to asking the US to start the process of withdrawing from the country. The removal of the US presence from Iran’s doorstep would go a long way towards pacifying the regime. Why risk an all-out conflict with the US when Iraq is now clearly an Iranian client state, and when Shia lawmakers have already asked the US to leave?
In any event, stocks were pleased with Trump’s apparent decision to eschew any further military action, especially in light of the president’s comments earlier in the week, when he variously threatened to bomb Iranian cultural sites. The stark juxtaposition between Trump’s tone on Sunday and Monday and his conciliatory remarks on Wednesday is further evidence to support the contention that the strikes on US bases were some semblance of choreographed – a made-for-TV event to give the Iranian people some respite during a national crisis made worse by the deaths of mourners in a stampede on Tuesday and a catastrophic 737 crash outside Tehran just after the missiles stopped flying Wednesday morning.
The turnaround in US equity futures was remarkable.
A similar reversal was seen in oil – EIA data showing crude and product builds only added to the bearish impetus. Ultimately, WTI – which spiked above $65 when news of the strikes first hit the wires – ended more than 4% lower.
Of course, it would be foolish for anyone to completely price out the geopolitical risk premium. We have certainly not heard the last from Iran, no matter which version of Wednesday’s events you care to believe.
But perhaps the most remarkable swing was in Treasurys. 10-year yields fell as much as 11.5bp when the flight to safety was in full swing. By the time the dust settled on Wednesday, reinvigorated risk appetite and a weak auction left yields between 4 and 6bps cheaper across the curve. 10-year yields were at 1.87% after falling all the way to ~1.70% in the panic bid that accompanied the hostilities in Iraq.
Who would have thought, in the midst of the drama on Tuesday evening (or Wednesday morning, depending on where you were when the IRGC started shooting) that the day would end with the 2s10s bear steepening?
As for the yen and gold, it’s the same story – the reversal is quite something.
It’s important to note that whether or not Iran itself decides to do something dramatic (e.g., fire rockets into Israel or attack the Saudis again), what’s certain is that eventually, the Houthis, Hezbollah and the militias in Iraq will strike someone, somewhere.
At that point, Trump will have to decide whether to hit Iran directly, or accept Tehran’s claims of plausible deniability. Those claims could conceivably have more merit now that Soleimani is gone. The Quds’ ability to micromanage Iran’s proxies may well be temporarily diminished, and you can be sure that Hassan Nasrallah – who Zeinab Soleimani calls “uncle” – is hell-bent on exacting some kind of revenge of his own. Of course, he wouldn’t act against the will of Khamenei, but the point is that this is still very much a “live” situation.
That, at a time when better than 80% of S&P 500 stocks are perched above their 200-day moving average.
Iran may be “standing down”, as Trump suggests, but the bulls are standing tall indeed.
It’s a long way down from here, and pride comes before the fall.
Just before the close, the siren sounded at the US embassy in Iraq. Several rockets hit inside Green Zone. No casualties were reported.