By Michael Every of Rabobank
As widely expected, as our Fed watcher Philip Marey covers here, the Fed left rates unchanged at 5.50% and will continue reducing its holdings of Treasury securities, agency debt and agency MBS by $60bn a month. There was no update of its economic projections, and only marginal changes to its statement, which was therefore more hawkish than expected. However, Powell very clearly put a September rate cut on display in the press conference.
Overall, recent developments in inflation and unemployment seem to warrant a rate cut ahead. However, inflation could still prove sticky, and Philip continues to think the Fed cuts based on worse ‘stag’ not better ‘flation’ data. He also strongly disagrees with the Fed’s projection of 4 rate cuts a year in both 2025 and 2026, which he thinks will be derailed by politics. Philip still assumes Trump wins in 2024 --as polls few read the methodology of show him far ahead and far behind Harris, and “no tax on tips” is joined by “no tax on social security” as a carrot for more voters than “no student loans” from the Democrats-- and imposes a universal tariff, making a rebound in inflation unavoidable. On that basis, we expect only two rate cuts in 2025, all in the first half, and nothing in 2026.
“Challenging days are ahead… We are ready for every scenario.” While this is appropriate wording for the US election and the global outlook if the Fed is only able to cut rates 100bp, it wasn’t said by Real Clear Politics or Powell, but by the Israeli prime minister last night. In a dramatic 24 hours, Hezbollah’s #2 was assassinated in Beirut, then Hamas’s #1 Ismail Haniyeh *in Tehran*. All see Israel’s hand behind it, and Iran’s humiliated Ayatollah Khamenei has pledged revenge, the New York Times reporting this will be a direct, coordinated ‘Axis of Resistance’ attack on Israel, as in April. Iran just closed its airspace for Haniyeh’s funeral in Tehran Friday, while Hezbollah’s #2 will be buried in Lebanon, followed by a public speech by leader Nasrallah. The recent pattern suggests any attack on Israel would follow within days, so could again fall on the weekend. How will you sit for this Friday’s close?
April’s Iranian attack on Israel was seen by some as geopolitical ‘theatre’, but as I pointed out, they were serious rehearsals for more to come, while the precision Israeli response was an indication of the strike capability perhaps just used in Tehran: regardless, there appears no play-acting now. US Defense Secretary Austin has stated the US will again defend Israel if it’s attacked. The Israeli press talk of swarms of explosive drones and ballistic and cruise missiles from multiple directions aimed at military bases in Haifa or Tel Aviv; and/or major cyber attacks to take down banks and utilities; and/or attempted assassinations of Israeli or Jewish targets internationally.
Crucially, Israel has reportedly used diplomatic backchannels to inform Iran that any major damage or casualties on its end means full-scale war. In short, Iran (and Hezbollah) will either have to back down and lose face, or finesse an attack that looks significant but damages little - where any misfire will trigger the regional war so many have been concerned about, or just start that war regardless, even if this was not the timing they would have chosen. There is a scenario where nothing much now happens – but it looks ever less probable than the far worse alternatives. As a result, markets are starting to move.
The first stage of the market reaction to geopolitics like this is risk off. US Treasuries were already bid post-Fed, but could get more of a lift. Gold is likely to go higher. The Swiss Franc, the Japanese Yen (already on a roll post-BOJ), and the US dollar benefit from this kind of backdrop, but Powell leaned against the latter so it will be interesting to see which sentiment prevails.
The second stage of the market reaction is energy. Oil prices moved slightly higher on the first assassination in Beirut, and again on the second in Tehran. Headlines of war risk suggest more of the same – and much more if missiles start flying. The question then is how bad things could get.
Note the recent Israeli destruction of the Houthi port and oil storage at Hodeida, a more significant blow to the group than anything the West has achieved via Operation Prosperity Guardian and airstrikes. This implies Israeli willingness and means to destroy Iranian oil facilities. That could reduce Iran’s oil exports from current estimates of 1.0 - 1.5m barrels a day to zero.
However, the global demand backdrop is hardly bullish for oil at the moment, and OPEC+ is still holding to production cuts to try to prop prices up. They could, if needed, surely fill any supply gap quite easily. That would suggest immediate headline-related oil price spikes might not be sustained for long. Unless it isn’t only Iranian energy targeted.
Hezbollah would certainly try to hit Israel’s offshore natural gas fields, which would have a moderate knock-on effect on European gas prices given what we have seen recently. Far more significant would be if Iran or its proxies targeted Gulf or Saudi oil facilities or shipping, as in the past. This is less likely initially given recent rapprochement between Saudi Arabia and Iran. However, any US or Saudi/Gulf assistance to Israel during an Axis attack on it, as in April, and especially if the US actually then *attacks* Iran back alongside Israel, might open that door.
So might an Iranian reaction to any more military blows if they mark a devastating setback to a geostrategy it has been successfully employing for years. There might be compelling strategic logic for Tehran to act in a destructive manner to force the US and Europe to back away from Israel and push for a ceasefire on better terms for Iran than it could otherwise achieve. That’s not an immediate risk, but it’s not one to dismiss if things escalate.
Iran could also accelerate its rush towards a nuclear weapon, which despite the naïve hopes of those who backed the 2015 JCPOA, and those who backed Trump sanctions, is reportedly very much on track. Were US or Israeli intelligence to flag that this breakthrough is close to occurring, or a public demonstration of such is somehow made, albeit long before such a device could be fitted to a warhead, it would force a massive global escalation, or an equally massive global capitulation. In which case, others would be taking notes and making plans.
So, yes, challenging days lie ahead, and you should be ready for every scenario.
Even one where rates don’t get cut that much, or where central banks don’t get the financial press headline.
