The critical factor is the flight to safety arising from the Iran war

Outlook

Today we get the US manufacturing PMI (which was 51.2 in the flash from 52.4 in Jan). Then we have to wait for the next big thing, the jobs report on Friday. The Bloomberg survey calls for a measly rise of only 60,000 jobs.

The critical factor is the flight to safety arising from the Iran war. Press reports have it that regular citizens are filling planes and highways to leave the region.

We also expect an extra push the new war in Iran will be giving the US Treasury market and the dollar along with it. The 10-year yield had already fallen to the lowest since last November, i.e., already below 4%. Bond vigilantes have been nowhere to be seen but may be emerging from the bushes now that ballooning oil prices could push inflation up.

This is still just an idea, although one that Bloomberg embraces—it always likes scary stories. And to be fair, when the US took on Iraq in Kuwait, yields did respond. It’s not clear the two wars are comparable. Iran is a far bigger and more formidable opponent than Iraq. And yields fell for over a month before responding to the oil/inflation story. Still, food for thought.

But one investment manager told Bloomberg—before the war-- “The market is far too big, liquid and dominant for it to be completely or easily cast aside as a flight-to-quality destination.” We say this still holds, inflation fear notwithstanding, for a while.  As for the war inhibiting central bank rate changes, it’s too soon to judge. We are only in Day Three. The BoE and Fed can hardly be expected to be factoring in upcoming oil-push inflation at this early date.

Now that we have an actual war that may last weeks, according to Trump, the big financial markets shock can last that long, too. Bottom-fishers need not apply. Note that Trump’s mention of weeks is political, not military.

There are two key possible outcomes: first, Trump chickens out and calls off the US participation in the war, leaving Israel alone and the job of regime change not done. He might do this if the incoming replacement Iranian regime has some real chops and does some real damage to the US bases and allies. He would seek to back out quietly and let the others in the region take over. This is not on the table yet—he is still basking in the limelight.

The alternative is to keep going until the replacement regime is conquered or gives up. Giving up is not the table, either. Weeks may well be optimistic—years might be more like it. The wild card is what Iran’s allies Russia and China might be thinking. So far they are the ones chickening out.

Forecast

If there is no end in sight for the Iran war, there is no end in sight for flight to US Treasuries and the dollar. This move will likely be more of a straight line than a wobbly one and we can’t count on things like turnaround Tuesday and spiky moves on the Friday payrolls report. One idea is that the nascent global recovery, especially in Europe, might get squashed. That leaves Asia doing business as usual, although limits on gold sales are interesting. 

US politics

Iran has been saying “death to America” since 1979 for support of the shah, who had gone to various countries and finally the US, for medical treatment, where he died. The shah had been restored to the throne in 1953 and reversed the nationalization of Anglo-American Oil by the previously elected government. Many essays and documentaries have disclosed that the coup bringing back the shah was orchestrated by the CIA and British intelligence.  But the opposition doesn’t say “death to Britain” and the UK has been keeping its head down for over 70 years. 

Political followers await the consequences of Trump declaring war when the Constitution clearly gives that power exclusively to Congress. Experts say there was no emergency backing up a national security excuse and the latest talks were actually getting somewhere, even though everyone knows Iran has always lied (and Iran knows we know it). Besides, Trump campaigned on keeping the US out of wars and now he is going for not one, but two regime changes. Bibi must have made him forget that the US has a lousy track record on regime change. 

Ahead of the first strike, only a minority favored the US attacking Iran.  But the case for the attack is not hard to make—nearly 50 years of “death to America” and Iran’s widespread and deep support for terrorists and general instability in the region. Cable TV is seldom this engrossing. Well-known moderate Stephens in the NY Times has an essay that includes this:

First, it’s a mistake to say that Trump got America into war on Saturday. What he did was respond to a war that Iran has been waging against the United States since 1979.

It waged war when it seized our embassy in 1979, murdered (via proxy) hundreds of our service members in Beirut in 1983 and supplied the I.E.D.s, or roadside bombs, that killed or maimed over 1,000 of our troops during the war in Iraq. It waged war when it sought to assassinate former senior U.S. officials, including John Bolton, Mike Pompeo and, according to a 2024 report in Politico, Trump himself. One reason Iran behaved as it did is because it drew the lesson that it would pay no great price. No more.

There’s more, like the Iranian connection to both Russia and China, but the critical point is that it won’t be all that hard to bring a majority around to the point of view that this war is justified. Just thank the stars it’s the Israelis doing the strategizing.