Dire Straits Of Hormuz

Submitted by Michael Every of Rabobank

Well, we didn’t have to wait long for ’John Wick: Chapter Portobello’ to begin, did we? Brent crude spiked 4.5% before giving up around half of those gains as a further two oil tankers--one Norwegian, one Japanese--were attacked in the Straits of Hormuz, forcing the evacuation of both vessels; that as Japanese PM Abe sat down with the Iranian government to try to dial down tensions with the US – and as the leadership refused to accept any message from President Trump. The US have now accused Iran of attacking the two ships, which follows on from two other recent tanker attacks, drones hitting Saudi oil pumps, and a missile hitting a Saudi airport this week. The easy market response was long oil, obviously, as well as a ‘Risk Off’ further leg down in bond yields. But who did this and why? And what does that say will happen next? Logically, it was either Iran, or the US, or a third party:

Iran is suffocating under US sanctions, a known instigator of such actions via proxies, and threatening the EU with walking away from the nuclear deal if they won’t help it out. An attack like this would be incredibly reckless…unless they are desperate enough to up the ante to see if a war-averse White House will press ahead with another ruinous Middle East conflict ahead of the 2020 elections and in the face of a Cold War with China. If that is the case then expect more provocations and more Risk Off even as Iran calls this all “beyond suspicious”, “economic terrorism”, and “sabotage diplomacy”.

The US is divided between neo-cons champing at the bit to take on Tehran, war-averse Trump, and a Pentagon now looking at China--and Russia--as the real threat: notably, CENTCOM has said a war with Iran is not in the US strategic interest – and it isn’t. Why would Trump order an attack on a Japanese ship just as Japanese PM Abe is in Iran as emissary to try to de-escalate (a situation the US has escalated in typically Trump fashion)? In short, although the US has from--Gulf of Tonkin, WMD--this seems less likely.

Third parties are a short short-list. Mainstream media will no doubt follow murky social media to point a finger at the Saudis and Israelis – and the latter more than the former. Yet would either want to precipitate a major war that would drag them in when economic sanctions on Iran are biting? Perhaps. But also consider the political blowback of being found out as war instigators in Washington could be existential.

In short, one could argue that the largest risk is that it is the Iranians who are upping the stakes vs. US economic pressure,…in which case the US has very difficult choices to make on both fronts. Jaw-jaw or war-war? The bell-weather(?) Fox News is already suggesting Trump’s hand may be forced by Iran’s actions. As with China and trade war-war that backdrop certainly supports our long-held view of lower yields, stronger USD, and weaker EM FX…and perhaps weaker GBP too given Boris Johnson handily won the first round of the Tory party leadership election and, barring error, appears to be next UK Prime Minister.

Even if we ignore politics/risk off/John Wick, lower yields lie ahead. Consider the RBA for example, as Aussie 3-year bond yields are now below 1% and 10s at 1.38% when we started the year at 2.31% with market talk (from others!!) of when, not if, the RBA would hike again. For years the Reserve Bank have been boasting about the strength of the labour market as I argued the jobs data are inaccurate, looking at under-employment argues there is lots of slack, and there are 15-20K of new arrivals every month. Now suddenly say the RBA says the unemployment rate needs to be as low as 3.5% to address those issues: given we are 5.2% and rising, that’s a whole lot of monetary policy stimulus ahead! Have they read back-issues of my Aussie monthly page? Had a Damascene conversion? Or are they looking at the housing market and saying “Whatever it takes, mate”.

I also must add that in the US we also just saw import prices negative m/m and y/y again with the Chinese exporting DEFLATION not inflation despite 25% tariffs on USD250bn of goods (albeit perhaps this hasn’t fully kicked in). Who pays for tariffs? Certainly not US consumers so far. Nothing for the Fed to worry about on that front anyway.

The one unalloyed good piece of news today is that there are tentative signs that the Hong Kong government might be prepared to delay the debate on controversial extradition legislation that has triggered discussion of existential risks to its status as a global financial centre. However, there are also calls for further public protests on both Sunday and Monday, and things can change fast…