Earlier in the week, President Trump indicated he saw no necessity for a negotiated settlement, proposing that the US could simply declare victory and cease hostilities.
The markets responded swiftly. Asian stocks rose 5%, marking the largest single-day increase in a year, as optimism grew that the Middle East conflict, which has been threatening global markets and energy supplies, may be approaching a resolution. This rebound follows the worst month for Asian shares in over 17 years.
What is Trump’s current position on the Iran war?
President Trump earlier signalled he is willing to end the US military campaign against Iran even if the Strait of Hormuz remains largely closed. He indicated the war may end within two to three weeks and that a negotiated deal is not necessary. Market experts believe it is the financial market strain that is pushing Trump to call it a day in Iran. A prolonged war could have serious economic consequences that Trump may have sought to avoid.
But, on Thursday, Trump came in stronger on Iran. In a speech to the nation on Thursday, President Donald Trump threatened to “hit” Iran “extremely hard” in two to three weeks and even hinted that the nation would be forced into the “Stone Age.” According to Trump, the US is getting close to accomplishing its strategic objectives in Iran, but he warned that military action might intensify in the upcoming weeks.
Still, going into a prolonger war with Iran could have economic consquences for the US and global economy.
“Three indicators are now acting as real-time guard rails on policy: oil prices, equity markets and Treasury yields. They’re sending signals to Trump he cannot ignore,” says Nigel Green, CEO, deVere Group.
“Each time the conflict intensifies, oil spikes, stocks fall, and yields rise. Each time there is even a hint of restraint, those moves reverse. The pattern now seems firmly established,” adds Green.
What has the war done to oil prices and inflation?
Oil prices have fallen below $100 after hitting a high of $119 in the days following the outbreak of the war. But they remain sharply elevated with gasoline prices at the pumps soaring past $4 a gallon nationwide, and oil prices are still up over 50% since the Iran war began.
Higher oil prices for longer are likely to feed through to inflation. If inflation reignites and stays elevated, rate cuts by the US Federal Reserve could be delayed and US consumers and businesses may end up paying a higher price. If inflation remains sticky, there is even a possibility of a rate hike.
What is happening in the US Treasury market?
Before Trump’s announcement, yields on Treasuries had started soaring, putting pressure on the $30 trillion US Treasury market. Investors and regulators pay careful attention to Treasury market operations because it serves as an important benchmark for global borrowing costs.
This week, auctions for two-, five-, and seven-year Treasury notes all saw low demand, causing rates to rise higher than projected. This is in sharp contrast to last month’s Treasury offering, which witnessed the biggest demand in the history of 30-year auctions. The short end of the yield curve is under extra pressure as rising oil prices push up inflation expectations and put additional Fed rate cuts on hold, with the prospect of a rate hike also growing.
What does this mean for stocks and US debt?
The US stock market has also been under pressure, with the Dow moving into correction territory after falling 10% from its recent highs. Trump’s announcement that the war may end soon has raised hopes of a recovery in the US stock market indices.
If the war does not end soon, it will put more upward pressure on oil prices and Treasury bond yields, both of which are likely to keep stocks from recovering from their current lows.
The cost of the war is also making America’s debt picture worse. With reports that the Pentagon is requesting $200 billion from Congress, the financial burden is mounting. The federal government may have to refinance $10 trillion of debt due in the coming year, and the budget deficit is already on track to reach $2 trillion. “With US debt above $39 trillion, the sensitivity to higher yields is far greater than in previous cycles. The margin for error is much smaller,” Green explains.
Oil is a reflection of current consumer pressure and inflation. Wall Street conveys financial circumstances and confidence. Additionally, the sustainability of government funding is determined by Treasury yields — something that Trump and his administration cannot ignore for long.
Disclaimer: This article provides factual analysis only and is not, and should not be construed as, an offer, solicitation, or recommendation to buy or sell securities. Investors must conduct their own independent due diligence and seek advice from a SEBI-registered financial advisor.