The political theatre in Washington has reached a new crescendo. President Trump, in a characteristically combative address, has condemned the House of Representatives' bipartisan rebuke of his Iran policy as 'unpatriotic'. This is the latest instalment in a saga that is eroding the dollar’s safe-haven premium and spooking gilt markets on this side of the pond.
Let us be clear: the macro implications of this constitutional spat are not trivial. The House resolution, which asserts that Trump must seek Congressional approval before engaging in hostilities with Iran, has sent a clear signal that the executive branch is in a straitjacket when it comes to foreign policy. Markets hate uncertainty. The VIX, or 'fear index', has ticked up, and we are seeing capital flow out of US Treasuries and into German bunds. The dollar index is under pressure.
From my vantage point in the City, this looks like a classic case of political risk repricing. The US is no longer the predictable hegemon it once was. The Iran situation is a tinderbox. The killing of Qasem Soleimani was a bold move, but the aftermath has been a masterclass in strategic confusion. The President’s dismissal of the House vote as a 'very dangerous' act of partisanship only deepens the sense that there is no cohesive strategy coming out of the White House.
What does this mean for the British investor? First, expect gilt yields to remain volatile. The flight to safety is real, but so is the prospect of fiscal stimulus in the US that could push up global interest rates. Second, the pound may find some support if the US dollar weakens further, but that is a double-edged sword if it reflects a broader risk-off sentiment. Third, the inflation picture is cloudy. Oil prices have spiked on Iran tensions, and that will feed through to petrol pumps and heating bills. The Bank of England is watching this closely, but they are in a bind. Inflation could rise, but so could unemployment if trade tensions escalate.
Let us not forget the fiscal angle. The US national debt is ballooning. The Congressional Budget Office has projected a deficit of over $1 trillion for 2020. This political dysfunction raises the risk that the US will be downgraded again, which would have severe consequences for global bond markets. The yield on the 10-year US Treasury note has already fallen to 1.8 per cent, but that is more about safe-haven demand than fiscal credibility. If the political climate worsens, that yield could spike as investors demand a risk premium.
The bottom line: the Washington crisis is a headwind for risk assets. Equities have been resilient, but that could change if the rhetoric escalates into actual conflict. The prudent investor should consider hedging bets with gold, which has already rallied to a seven-year high. Volatility is the new normal, and the City must adapt to a world where the US is no longer the bedrock of stability. This story is far from over, and the market will be pricing in each twist and turn. Stay nimble.
