Iran conflict poses new risk to US economic resilience
The Fed's concerns quickly reverted to a sharp rise in inflation, however, and rate hikes were accelerated.
"The conflict with Iran is a wild card, though markets may quickly lose interest if the situation looks likely to devolve from a regional to an internal conflict," Tim Duy, chief U.S. economist at SGH Macro Advisors, wrote on Monday.
In a separate note, SGH President and CEO Sassan Ghahramani, a Tehran native whose father was an Iranian diplomat before the 1979 Islamic revolution, pointed to the uncertainty of the current moment, with the possibility of an Iranian civil war as well as "a 'scorched-earth' tactic of escalation from Tehran to (other) civilian centers ... to hit the global economy, and pressure an end to the war."
RISK OF PROTRACTED ASYMMETRIC CAMPAIGN
The initial market impact seems contained. Interest rate futures showed little change in expectations that the Fed would cut rates at its July 28-29 and September 15-16 meetings. The yield on the 2-year U.S. Treasury note fell over the weekend, a common reaction in moments of global crisis as investors seek out safe-haven assets, but yields on Treasuries were rising on Monday in a possible sign of concern about rising inflation, at least globally. The dollar, another safe-haven outlet, rose against a basket of major currencies. Major U.S. stock indexes were mixed in late-morning trading.
"We do not expect geopolitical developments to significantly affect Fed policy rate plans, with modest upside risk to inflation offset by less supportive financial conditions" and a focus on domestic data, Citi analysts wrote in a note on Monday. "We expect 55,000 new jobs and 4.4% unemployment Friday, a reading that should keep Fed officials optimistic that labor markets are stabilizing."
The U.S. Labor Department is due to release its employment report for February on Friday.
Jason Thomas, head of global research and investment strategy at Carlyle, however, noted the difficulty of predicting where the Middle East conflict will lead.
He put only a 30% chance on Trump succeeding in replacing the current Iranian regime, with the Islamic Revolutionary Guard Corps likely able to pursue an "asymmetric" response that may extend beyond obvious chokepoints like the Strait of Hormuz.
Iranian drones did hit natural gas facilities in Qatar, causing it to shut down LNG production from facilities that use the Strait.
But Thomas said he was focused on "a base case probability of 70% or higher for a protracted asymmetric campaign, including cyber activity, terrorism, and proxy forces that could engulf Iraq, the second-largest producer in OPEC." Though U.S. power is focused around Iran, "who is protecting Mozambique's LNG?" he asked.
(Reporting by Howard Schneider; Editing by Paul Simao)
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