The United States has launched retaliatory strikes on Iran following an attack on an American cargo ship. For those of us who watch the markets, this is the kind of geopolitical shock that triggers an immediate flight to safety and a re-pricing of risk. The US dollar is strengthening against a basket of currencies, while gold is pushing higher.
Oil prices are spiking, as traders price in the risk of supply disruptions through the Strait of Hormuz. The question now is what the fiscal cost of this confrontation will be. Defence stocks are up, but the broader market is selling off.
The US government, already running a deficit of 6% of GDP, will now face additional pressure to increase military spending. This is not a war that can be funded by printing money without consequences. The Federal Reserve will be watching closely.
A sustained rise in oil prices will feed through to inflation, complicating the central bank's rate path. The yield curve is already inverted, and any further rise in long-term yields could tip the economy into recession. Capital flight from emerging markets is accelerating, as investors seek the safety of US Treasuries.
But with the US fiscal position deteriorating, that safety may prove illusory. The bottom line: this strike is a gamble. The US is betting that a short, sharp response will deter further aggression without triggering a wider war.
But the market is pricing in a higher probability of protracted conflict. Volatility is back, and it is here to stay. For investors, the only certainty is uncertainty.
Hedge accordingly.
