…….and then it was all fine! The Americans dropped some half a dozen of their big-bunker-busting-bombs in targeted strikes at Iranian nuclear facilities and we were then assured by President Trump “it was a spectacular success”. The Pentagon’s leaked Defence Intelligence Agency’s report has said the strikes have only put Iran’s nuclear programme back a few months. One report indicated damage to doors and not much else.
When I saw this, I was instantly reminded of the film “The Italian Job” (1969) with Sir Michael Caine (the originals are always the best). In one scene they are testing out explosives to be used on the gold bullion lorries. They used so much, it blew up the entire vehicle. Michael Caine turns round to them and says “you were only supposed to blow the bloody doors off”. Well, here it seems that’s all they did!
Straight after, we had the usual rocket strikes, first by Iran, and then followed by Israel. Subsequently, Iran launched some well-calculated strikes close to US bases and in Qatar aimed at doing nothing, basically the appearance of retaliation. Trump really lost it with both and warned them (primarily Israel) to stop – which they did.
Since then, there has been no escalation. I get the distinct sense Trump felt obliged to appease Israel with some action and now, for the sake of his MAGA voters, just wants an end to all this – regardless of whether it was a “spectacular success” or not. For now, we have a ceasefire and it’s holding. Meanwhile, Iran get to live another day – and it’s anyone’s guess what they have done with their enriched Uranium stockpiles!
In terms of market impact:
1) We had a risk-off-reversal as with markets rallying everywhere – equities and corporate bonds. US Treasuries regained some lost ground – though non-US Sovereigns continued their selloff.
2) Oil plummeted to where it was before last weekend’s frenzy. That will certainly alleviate input pricing pressures and pretty much cancel out the big rise I spoke about in last week’s weekly. Early indications now point to a benign effect.
3) Worth taking note that, as things stand based on all the tariff discussions that have taken place so far, we are looking at an effective (i.e. weighted-average) tariff rate by the US of 15%. This has come down a long way from its dizzy heights of before. It really helps. Even at 15% it is inflationary – but much less so. I continue to believe people are still overestimating the impact of tariffs. Even “tariff noise” from non-US nations is starting to quieten ahead of the 4th July deadline.
4) Another factor driving down bond yields (in the US) is the continuing spat between President Trump and Fed Chair Jerome Powell. Markets believe the latter’s future remains in doubt. His term expires in May 2026 anyway – so not long to go. Trump wants rate cuts immediately…..while Powell has been holding off to see what impact tariffs have on inflation and the wider economy.
Regardless of the view one holds, recent “Fed chatter” from Fed Board members (e.g. Waller, Bowman, Kashkari) are citing grounds to cut rates on the back of softening economic data. Look at the Citi Economic Surprise chart below. There has been a downward shift in the hard data index and, with it, the US$ index has resumed a downward trend. It feels as if there is some friction within the Fed ranks – with Powell set to leave May next year (even sooner), there will be those vying to replace him from within if Trump doesn’t find a successor from outside. One big surprise on Monday this week was Fed Vice Chair, Michelle Bowman, who stated she would consider voting for a rate cut as soon as July if inflation pressures “remain contained”.
How many cuts? No consensus yet – but they range between two (favoured) to one – all by year-end. The latest “dot plot” points to two cuts of 0.25% each. If this materialises, it will certainly alleviate pressure on the long-end (30y US Treasury) of the yield curve which is still dangerously close to settling above 5%. That matters because when you look at the sheer wall of debt that needs to be refinanced over the coming years, buyers will want higher-yielding compensation for that risk. All that, in turn, jacks up interest servicing cost.
On Tuesday (24th) this week, we hosted a Global Macro update. It looked at the “implications of the ever-rising debt mountain”. The key takeaways were quite simply this:
1) Unlike most economists who don’t worry about total debt but, instead, are panicking about the US$ – my view is the other way round! This time, the debt matters because it has a true cost attached to it and that carries a very high price (= debt-servicing cost). In the decades prior, we lived in an almost free-money environment (negligible rates, negligible inflation and high growth). That’s now gone!
2) …..So too have the high levels of growth. The US needs to attain nominal growth in the order of 4.5% to 5.5% to keep ahead of its own, growing debt mountain. Instead, it’s achieving just well under half. It’s a similar story around the globe. Even China is settling on less than target rates – and that was even before the tariff saga.
3) Fiscal deficits are ballooning. The US’ fiscal deficit – before interest payments (aka primary deficit) – is around 3.5% of GDP. Its total deficit is 6.5% of GDP. 3% of its GDP goes on servicing debt. That’s scary!
4) The US$ is going through a correction. This has been the case since the 1960s and 1970s. In fact, on a Trade-Weighted basis, its is higher than it was vs the 1970s. Yes, it has sold off partially due to perceived political instability around tariffs and geopolitics – but it has more to do with risk on (US$ falls) / risk off (US$ rises). If the US$ is going to be displaced, it will take many years. First you need a replacement – and one doesn’t exist. Gold is an excellent hedge (hence stockpiling among EM nations) but we’re not going back to the gold standard any time soon.
What are the key factors for any portfolio today?
- Thematic long positions: technology, infrastructure, commodities.
- Yield: In liquid markets, this is hard to find. However, in private markets, it’s very attractive and short duration (see “Hedges”).
- Hedges: As I mentioned, Gold. If the world falls apart (be it for geopolitical and / or monetary reasons) then even better. Other ways to hedge – keep your duration short (max 2y to 3y) – it’s less sensitive to mid-to-long end rates. The short end also horizon just about in sight. Commodities (selectively) provide a natural hedge to the US$. It won’t be oil though – the best it could do was to bounce to the mid/upper $70 range during the Iran-Israel spat. If you think US$ is going to steadily decline, be careful not to get too exposed to petro nations. Saudi is one such example – the Riyal is pegged to the US$. Both a declining US$ and Oil price is bad news for their high spend aspirations. The bulk (over 80%) of its exports are oil-dependent. It’s a tough ask.
MARKET SUMMARY…
