So, is it all about the Oil?

Outlook

It seems clear that most currencies are suffering from a flight to the safe-haven dollar, even the Swiss franc and the Chinese yuan. To be fair, both are prone to intervention, and indeed, Reuters reports “The Bank of Japan warned of possible intervention to arrest yen weakness, while the Swiss National Bank said it was more willing to intervene to counter the safe-haven franc's rise. The ​resulting fallback in the franc tallied with a curious retreat in gold.”

We need to worry about that strange jump in the 10-year yield, too. It can mean any or all of several things, including a renewed worry about US inflation arising from last week’s PPI and bolstered by the ISM manufacturing input price jump.

The CME Fed Watch tool shows that the probability of a rate cut in June was 42.8% a week ago and has faded down to 33.8% now. A big 62.4% think rates will be the same in June as now, from 50.4% a week ago. Nobody can untangle what is due to war and what is due to inflation expectations.

As for Europe, the first talk about the war’s effect on the economy was overly optimistic. But then the entire continent’s reliance on natural gas came into focus as Iran closed the Strait of Hormuz and bombed oil and gas facilities all over the region, especially in Qatar. Shutting down the Qatari facilities and export capability is a big deal for Europe. Yesterday QatarEnergy has halted production and declared force majeure following drone attacks on its primary facility. See the chart from Reuters. Natural gas prices have already doubled.

And here comes politics again. The rest of the world does not trust Trump, and rightly so. Why would anyone trust the US to continue to supply the world with oil and natgas under Trump? The US is a net exporter of both and in fact, supplied 58% of the EU’s LNG last year. Now Trump says he will do something about fixing the rising prices of oil and gas to Americans, although we await how he thinks he can do that (and everyone knows Trump lies). He isn’t saying anything about helping Europe.

Therefore, to some unknown extent, the rising dollar is due at least in part to energy self-sufficiency and not really the old safe-haven narrative. The weakness in energy-less economies (Japan, SE Asia) can contribute to currency softness. It’s a little odd that energy rich economies like Canada and Australia are not doing better.

Forecast

So, is it all about the oil? Well, maybe more than anyone likes to admit. Since the war is going on for another 4-5 weeks or more, we can’t expect respite in this quarter, and that means the dollar has more room to run. It’s helpful that the re-emergence of US inflation is pushing out the probability of rate cuts, too.

One worry: Trump doesn’t like the stock market in retreat. He thinks the S&P is about him. What changes would he make—like accelerating the end of the war—to get the equity indices running up the flagpole again?

Points of view

BoA/ML has a nearish-term outlook (from now to 3 months) that includes these: “U.S. economic uncertainty rises but fiscal and monetary supports keep the U.S.’ economy clear of recession and profit growth intact.

“Higher global oil prices have a larger near-term economic impact on net energy importers like Japan, Europe and China versus energy-independent U.S.

“U.S. dollar shifts from slight weakness to strength. Oil and Gold prices rise (price hikes could be sharp if tanker passageways are shut). Energy sector rallies. Defense industrials rally.” There’s more, but the point is that while the position here is not complacency, panic is not called for, either, at least not yet. Trading opportunities exist

For the 6-18 month path, here’s what to expect:

Equity volatility declines toward normal levels. Equity markets normalize and begin to track corporate profit fundamentals.  U.S. dollar resumes a slightly weaker path

Credit stabilizes and begins to outperform Treasurys  Higher-quality Equities including shares and solid dividends join the leadership ranks.

Technology and Financial shares stabilize.  Utilities and Industrial remain leaders.

Oil prices exhale but Gold prices remain in uptrend.  Mid-term election concerns gather steam prompting investors to add to non-U.S. exposure.  Equity market rebalancing continues with equal-weighted S&P 500 outperforming and sector diversification in demand. Economic growth globally and in the U.S. surprises to the upside.”

We rather like that last sentence.

Ah, but ECR Research, with a European perspective (the Netherlands) is a lot less sanguine. ECR focusses on the Strait of Hormuz, which carrries “Twenty-one percent of the world's traded oil and 25% of LNG… Shipping has already declined by approximately 70%. This creates an asymmetrical means of power that even a militarily weakened Iran can wield for months to come.”

The remnants of the old government must be defeated to avoid a damaging effect on oil importers, including Europe and Asia. If the remnants persist, they will have to promise to give up nuclear ambitions in a deal brokered by other regional powers. This will not satisfy US hawks but it’s one possible outcome.

“A disruption or blockade of Hormuz could drive up oil prices sharply, with far-reaching consequences for transport costs, inflation expectations, and monetary policy space. Central banks in import-dependent regions face a classic dilemma: raising interest rates to combat inflation or pursuing a more accommodative policy to prevent recession.”

It seems obvious that the US and Israel need to take over the Strait of Hormuz or damage Iran’s capabilities so badly that oil can flow again. Analysts have been pointing this out for some six decades. We can be fairly sure the aggressors know it by now. The question is whether they can achieve it. If they do, sell your oil stocks. 

US politics

Trump’s inability/unwilingness to name the goal of the Iran war is making it clearer than ever that he has no plan and never did have a plan. Netanyahu is the guy with a plan and Trump is just his bully wingman. Many analysts and commentators who would have been expected to oppose the war are now praising it, almost entirely because of the impressive military performance.

But now they acknowledge regime change is not the mission, meaning the whole enterprise may be a giant waste of blood and money if in the end the allies can’t finish the job and end up with Autocracy Light instead of Autocracy Monstrous. Autocracy Light, when we find out who that is, may promise to pull back from sponsoring proxy terrorists and promise to end nuclear enrichment, but obviously no one should believe them.

We should believe Iranian threats to the US homeland—cyber, electrical, water, etc. These guys are super-competent. And this newest self-inflicted threat comes just as we have unqualified incompetents at the FBI and Homeland. The FBI’s top counter-terrorism cyber guy was fired last week.  Homeland is run by the over-Botoxed puppy-killer and has been focused on terrorizing the state of Minnesota and finding a town, any town, that will allow warehouses to be converted to concentration camps for immigrants to be stashed without due process.

A proper autocrat makes the trains run on time. Trump doesn’t know where the train station is located, let alone who is manning it. If Iran manages to hit the US where it lives in any significant way, the November midterms go to the Dems.