Markets digest Middle East conflict as oil spikes, the dollar rallies, and volatility surges. Energy leads the story–but software surprises.
KEY TAKEAWAYS
The conflict triggered a sharp spike in crude oil, driving inflation expectations higher and reversing bond yield declines. Rate-cut probabilities were reduced as markets priced in the risk of energy-driven inflation.
The President’s signal to protect shipping in the Strait of Hormuz stabilized oil prices and helped equities recover intraday losses. Markets interpreted the move as an effort to prevent sustained energy inflation.
The US Dollar strengthened as global risk aversion increased, reversing the recent “sell America” trade. Safe-haven flows returned quickly when volatility moved two standard deviations above the mean.
Volatility surged but remained orderly, with the VIX spiking before partially retracing. Equity indices showed resilience despite wide intraday ranges.
Sector performance beneath the surface was notable, with software and banks stabilizing despite prior weakness and recent private credit concerns.
MY HOT TAKES
Energy–not equities–was the real policy trigger. The administration understands that gasoline prices influence both consumer sentiment and Fed policy expectations.
Markets are displaying discipline rather than fear. The relatively modest decline in the S&P 500 suggests investors view the conflict as contained, at least for now.
The reversal in rate-cut expectations underscores how fragile the disinflation narrative remains. A sustained crude spike would materially complicate monetary easing.
The outperformance in software suggests that defensive rotation may be stretched. Bargain hunters appear willing to step into oversold growth names despite geopolitical risk.
Currency strength reflects capital gravity. When global stress rises, US assets still attract flows–regardless of political narratives.
You can quote me; “A supply shock in the Strait of Hormuz affects the price of crude pumped out of the Permian Basin—despite being 8,000 miles away.”
Look both ways. The conflict in the Middle East is far from over, but, at five days in, now may be a good time to see where we are. The conflict opened with a relentless joint attack on Iran's military complex and its regime leadership. Yesterday, the administration flashed the first signs that it is popping its head, cautiously, out of the fox hole to assess the situation. Based on President Trump’s announcement that the US would “soon” move to protect shipping through the Strait of Hormuz and to provide an insurance backstop for shippers, it is clear that the President is aware of the sharp spike in energy prices.
Once the President made those admissions, markets abruptly changed course with crude prices easing, and stock losses pairing. Undoubtedly, market watchers wondered–albeit quietly–if this was the famous “Trump Put.” It is not likely, however, that the President was looking at stocks which were down by some -2.5% earlier in the session when he decided on the strategy. No, it was more likely crude–up by some 8% at one point–that caught his eye.
This is a president that is acutely aware of the importance of energy. My famous quote: “oil is THE oil of ALL industry” does not escape him. To be sure, the President is also aware that significantly higher energy prices will hamstring any case for easier monetary conditions. Remember that crude oil prices–regardless of where supply comes from–determine the price at which it trades all over the world. Put more simply, a supply shock from a chokepoint in the Strait of Hormuz, affects the price of crude oil pumped out of the Permian Basin in the US–despite being 8,000 miles away.
Not your problem? It sure is. Check out the chart that follows to see just how the already slowly-rising price of gasoline spiked in response to the Iran conflict. It’s not just prices at the pump. The EU in particular is highly reliant on LNG from the Gulf region. 20% of global LNG also travels through the Strait of Hormuz annually. LNG supply shocks will undoubtedly cause electricity prices to rise–especially in the EU, which is more reliant on LNG than the US.
Energy and equities were not the only things on the move these past few days. The US Dollar caught a healthy bid as well (check out the chart that follows). There has been much debate about what caused its sharp rise. While the near-term relationship between crude oil–intermediate is priced in US Dollars–and the Dollar is statistically unclear, the Iran conflict certainly gave the currency a safe-haven lift. The recently popular “sell America” trade is not so attractive when global risk conditions are 2 standard deviations from the mean. In other words, when the 💩 hits the fan, even the haters grab for US assets. Grab away, haters.
Now, moving over to the capital markets. Bond yields rose since the conflict erupted, reversing recent declines. 10-year maturity yields gained as much as 15 basis points, likely in response to higher inflation expectations caused by the spike in energy prices. Shorter-maturity yields also gained, driven by eroding bets of Fed easing–also in response to the spike in energy prices. On that note, Fed Funds Futures paired probabilities of rate cuts. Last week, futures were anticipating a 100% chance of 50 basis points of cuts and nearly even odds of another 25 basis-point cut by year end. This morning, futures are pointing to 25 basis points and an 80% chance of another 25 basis-point cut by year end.
Since last Friday’s close, the S&P 500 is down by just under -1% which, considering the magnitude of the action, feels rather underwhelming. Of course, there is more to that number under the surface. In both Monday’s and Tuesday’s sessions, stocks traded in fairly wide ranges in what appeared to be attempts at dip-buying. The VIX volatility index jumped from 20 to 25 by Monday’s open, but closed at 21, only to spike as high as 28 yesterday, before closing near 24. You could say that the volatility index has been volatile. 🤣 This morning has the VIX down slightly at around 22. That translates into an expected daily move in S&P 500 of around +/- 1.4%. Here are some fun facts for you. Pay attention. Over the past 2 trading days The S&P 500 is down by -0.9%, Financials are down by -0.47%, Banks are up by 0.21%, Tech is down by -0.16%, and Software is up by 3.15%. Need I say anymore? I do, lol. Pressure on banks has appeared to let up despite the recent spate of negative news in private credit and BDCs. But Software…SOFTWARE, the recipient of group-hate for the past several weeks, outshone in the past 2 days, making it clear that there are bargain hunters out there.
All in all, despite the magnitude of global events, markets appear to be digesting the news efficiently. As expected, volatility is most acute in energy. Bond markets are reflecting a potential for a bump in inflation, and stocks–stocks are taking it all in stride. If we widen our field of view and return to the prevailing secular trend of rotating out of growth, one wonders why it was not materially accentuated given the conflict. Could it be that those safe, defensive sectors actually look rich as result of recent rotating? As the situation further stabilizes in the coming weeks, investors may find themselves lured to the relatively cheap valuations in some of those beaten-down corners of tech. Folks, this is far from over, but like always, situational awareness is paramount. For now however, the move is: keep calm and carry on.
YESTERDAY’S MARKETS
Stocks closed down, but above session lows as the conflict in Iran intensified and crude prices spiked. President Trump’s suggesting support for maritime transit through the Strait of Hormuz provided temporary respite for stocks which closed on a positive note, but still in the red.
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