The Iranian war has again risen

Outlook

The Iranian war has again risen to the top of the economics factor list. There is no end in sight. Intelligence experts say the current level of offense/retaliation will not change minds in Tehran, while in Washington, Trump fears all-out war, which would mean boots on the ground. Even if the intermediaries manage to get talks started again, it won’t be any more real and effective than the last ceasefire, talks and memorandum of understanding. 

Revival of the talks will generate wishful thinking and pullbacks in yields and oil from time to time, but bottom line, the consensus is building that this is going to be a long war.

That means ongoing pressure on oil prices, refineries, inventory in storage, and all the oil-related products. Supply chains can be quite flexible and adaptive, but this is a vast set of industries across a vast map. We have probably seen the price of oil back near $70 for the last time for a very long time.

If this scenario is correct, then one-time dips in inflation as we just saw in the US are meaningless. Everyone’s inflation is going up and if the ECB and Fed are sincere about fighting inflation, so are rates. A decent labor report in the UK today leads to the idea the BoE can sit on its hands for a while. A realistic assessment would say otherwise. 

The oil traders are jumpy and fracking the news minute-by-minute, along with traders in the 2-year. Brent went well over $91 and the 2-year hit 4.23%, both then retreating on the fake news that talks might be starting up again.

Forecast

The big picture (and longer term charts) point to rising US yields and a rising dollar. The upside breakout in the euro and pound, plus most of the EM’s (peso, yuan) is hanging on to the cliff edge by its fingernails.

The remarkable aspect of current conditions is that equities are moving in response to oil prices along with yields. There is some logic here—higher inflation, higher interest rates, equities down—but we can’t remember equity indices moving in lockstep minute-by-minute with oil. Why is this not an indicator of an unstable set of markets?

Food for Thought

Last week Deutsche Bank pondered that the dollar is becoming a risk asset, rather than the top leading currency and safe haven. This assumes more and more trade can get done with tokens, taking away the numeraire function, as well as the long-run asset savings, aka reserves. According to the summary in investinglive, “The logic: if global leadership flows from access to the deepest, cheapest capital, then tokenization lowers the walls and widens America's lead. Stablecoins are the payments layer; the bigger prize is settlement for tokenized assets.”

There’s a bit of truth in here, but not (probably) in our lifetime. A currency becomes the reserve currency because central banks want to have liquid cash on hand to buy food and armaments in an emergency. At what point will governments feel confident that crypto is liquid enough to perform that function? Not to mention stable enough.

As for foreign capital flowing more to equities than to government debt and government debt a Trumpian mess, okay—but a short-term thing. It’s still true that the US bond market is bigger than all the others in the world combined. If you want safety and yield, it’s the only game in town. Who guarantees crypto? Nobody, unless it’s a stablecoin, which in the end is a dollar or some other currency, anyway.

All the same, you must admit the ideas are alluring: “… the message is coherent: the dollar is being re-rated from safe haven to growth asset and it should trade that way. It's increasingly funded by equity flows, levered to the AI trade, and facing a slow bleed in official debt demand — while the cheapest major currencies in the world sit across the Pacific with catalysts stacking up. For anyone running unhedged dollar exposure on the old countercyclical logic, this note is a warning shot.”

This is a bit of wishful thinking. Markets do not like Trump because he is reckless, self-absorbed and not bright about so many critical things. The dislike spills over to the US at large, which is not unfair because after all, we elected this blundering bozo. But there are only 106 days to the midterms, which will flatten Trump’s sails, and then another two years before we get a chance to elect someone better. That shouldn’t be too hard—it’s a low bar. And that other question endures—who is to replace the US in finance? It’s not going to be imaginary money on a fleet of computers. Hope springs up periodically about the eurozone but flails around before retreating again. Honestly, the only real contender is China.

Background to know

The Conference Board index of leading indicators is a big deal but covers ten factors, each of them a big deal in its own right. That includes the S&P, the yield curve, factory orders, unemployment benefits, building permits, and consumer expectations, plus some others. The index tends to peak before a recession some 12 months later, so expect some gloom and doom if this one is robust.

Whatever the outcome, the bottom line is the same old robust and resilient US economy. Despite the price of gasoline going pretty high, consumers are not all that worried. Credit card delinquencies and defaults are actually falling—see the chart from the St. Louis Fed. To be fair, pawn shops are thriving, too.

The consumer is two-thirds of the US economy. It may be nice to see a wider distribution of non-residential capital investment than just data centers, but manufacturing, only about 9.4% of the economy, is down is not out.

Political Tidbit: Trump was booed by the audience when he pushed his way into the trophy presentation at the World Cup. And the verdict after last week’s speech: lies and misrepresentations. The TV channels were right not to carry it. Yesterday Nate Silver writes “Donald Trump’s approval rating has improved somewhat over the last few weeks. It hit a second term low of -20.2 back in May. But today, Trump’s net approval rating is up to -17.4.”

Keep in Mind: The government is going to jigger the inflation numbers for August in the Sept report.

This is not likely political interference but a normal process at the Bureau of Economic Analysis, which will adjust the previous five years, too. The changes will “eliminate some of the unusual discrepancy that has opened up between the PCE rate and the better-known consumer-price index. Annual core CPI inflation was 2.6% in June. Economists estimate core PCE was 3.3%.

“Usually, CPI inflation runs slightly above PCE inflation. The latter is higher now in part because of software and investment-management readings, which will likely show lower increases after revisions. Statistical agencies regularly tweak their indicators. This makeover is getting added attention because it comes at a crucial time for monetary policy. Though the likely effect is small, it could, at the margin, weaken the case for a rate hike.”