The Impact of Iran on the T10

The joint US-Israel strikes will be difficult for markets to price. Flight to safety vs inflation. How long does it drag on? Do we get sucked into ground intervention? Military operations are likely to continue for weeks as we root out remaining leadership and strategically important sites, so our best case scenario is that things settle down by the end of Q1. 

Iran formally closed the Strait of Hormuz yesterday. That's roughly 20 million barrels per day, or about 20% of global consumption. Something tells me upcoming military strikes might focus on control of this 21 mile wide waterway…

Iran released a video of a smoking tanker it supposedly sank for violating the Strait’s closure. But this was later identified as an Iranian tanker. This is like me releasing a grainy video of me dunking on someone and then you later learn it was just a 6’ rim and that someone was my son.

While these attacks are the natural culmination of the attacks on Hamas, I think it’s more reminiscent of Iraq 2003. This was a decapitation strike, not a war of attrition fought in tunnels. Iran’s regime has been toppled. The remaining power players are clinging to power via oil and threats of nuclear retaliation. I’m not sure de-escalation is available to them at this point even if they want it.

Like 2003, the removal of a leader isn’t the hard part - our military is incredible. It’s the subsequent power vacuum and governance that is the messiest.

Last Week This Morning

• 10T: 3.96%·
• 2T: 3.38%·
• SOFR: 3.67%·
• Term SOFR: 3.67%·
• Inflation – hotter than expected, which would have mattered any other week

Flight to Safety vs Inflation

I expect some interest rate tension in the coming weeks. Military actions of this magnitude usually create a flight to safety and push yields down. But given that oil could surge above $100/barrel, it’s hard to overlook the inflationary effects.

Keep in mind that the 10 Year Treasury had already pushed below 4% before the strikes. That movement was driven largely by continued fears of labor market weakness after Block laid off 40% of its workforce (4k employees) and cited AI. Never mind that Block CEO Jack Dorsey is FOS. While great at building businesses, he’s terrible at identifying macro events (he was the town crier for hyperinflation going north of 12% and changing the world order). I had planned on dismantling his AI claims by pointing out how much he over-hired, but then the attacks happened and my plan changed. Just know that I don’t believe him one bit that these layoffs are about AI.

So markets were already on edge and then we attacked Iran. The T10 pushed down to 3.93% in closed markets following the attacks, which is tough to do. That implies at least a 15-20bps movement had the attacks occurred during the week with markets open.

That does not mean the T10 will necessarily plunge when Asian markets open Sunday night, but there is definitely a bias towards it.

The flip side is inflationary concern. But inflation is a distant second vs stuffing cash under the world’s mattress when war breaks out. Inflation will absolutely matter at some point, but not until we have more clarity around the military actions.

I initially wondered if the inflation story might be muted. OPEC announced a production increase on Sunday. We basically seized Venezuela’s oil last month. The US already has considerable oil reserves. Maybe the media is overstating the significance of Hormuz?

Nope. All those all pale in comparison to the impact if the Strait of Hormuz is closed for long.

As I noted earlier, 20mm barrels a day move through Hormuz – 20% of the world’s consumption every day. Some counterbalances include:

• OPEC increased production by 200k on Sunday
• Venezuelan tankers that the US has seized generously have 10mm barrels, which is just 12 hours worth of Hormuz traffic
• Venezuela’s reserves are 300B barrels, the largest in the world. Yay! But it’s stuck in the ground. Venezuela is only capable of extracting about 1mm barrels a day. It’s a 5-10 year, $150B infrastructure project to change that. Let’s send some of our Houston people down there for the next decade and remedy that.

All told, maybe we can offset about 5% of the Hormuz impact. Maybe.

Which tells me Iran will not retain control of the Strait of Hormuz for very long.

Key technical resistance levels: 3.93%/3.86%/3.62%

You may recall 3.62% as the high side resistance level that held for nearly a decade. I don’t think Iran news alone can break through that level, but if it does that could be significant.

What does the Fed do?

Given the hawkish bend of this current Fed, this will only make them less likely to cut anytime soon. The last mile of inflation has been stubborn and upward pressure from oil will only make that harder.

Yes, I know that Core PCE strips out oil, but only directly. The indirect cost of higher oil still impacts the other components of the inflation measure.

The only reason the Fed cuts anytime soon is if the labor market falls apart…thankfully we get the next report on Friday.

The Week Ahead

Friday brings the next jobs report, but obviously that will be overshadowed by any news on Iran. Prayers to our friends and family in Israel and as a veteran, I hope no US troops have to set foot in Iran.