More jaw-jaw less war-war?

• Japan, UK and Europe equities showed relative resilience by advancing +0.8%, +0.7% and +0.5% respectively in sterling terms

• Asia ex-Japan, emerging markets and US equities fell -1.8%, -1.6% and -1.2% respectively in sterling terms
• Government bonds were volatile, with yields mostly rising as prices fell

With the Iran war entering its fifth week, equity and bond market volatility remains high, as all sides give mixed messages about how it might end. Brent crude oil is on track for its biggest ever one-month jump of around +60%.

The Strait of Hormuz chokepoint – through which roughly 20% of global oil passes – is developing from a flow-shock to a stock depletion problem as tankers offload their holds without being able to refill them. This effect is taking time to unfold. Cargoes from the Gulf take roughly 10-20 days to reach India before landfall in North-East Asia. Europe and Africa take about 20-35 days, with the US Gulf Coast at the end of the chain at roughly 35-45 days. Regional scarcity will vary. Higher prices may mean input costs into many industries may not be economically viable, in turn destroying demand as production runs are curtailed or stopped. South Korea is reportedly considering extending driving curbs already in force for civil servants to the general public.

This is one reason why the benchmark Brent crude price, currently around $115 per barrel, would not be sustainable for long at prices nearer to $150. High oil hurts demand.

The impact of the war is now starting to come through in industry data. Last week, forward-looking Purchasing Manager Indices (PMI) reported broad-based drops in Services and Manufacturing across the US, UK, eurozone and India. With a reading above 50 signalling expansion, Services PMI in the UK fell to a six-month low of 51.2, while the Manufacturing PMI fell to a three-month low of 51.4. Manufacturers signalled the steepest rise in input costs since October 2022. 

Last week the Organisation for Economic Co-operation and Development (OECD) estimated that the UK’s economy would only grow at 0.7% this year rather than the 1.2% it forecast before the conflict. The UK’s February inflation figure – as measured by the Consumer Prices Index (CPI) – may now be ancient news, but at 3% it showed that underlying inflation was stubbornly high before the Iran war. Looking ahead, this sets an awkward interest rate challenge for policymakers at the Bank of England.

In the eurozone, firms’ costs are rising at the fastest rate for more than three years, and supplier delays have jumped to their highest since mid-2022, largely linked to shipping issues. This lends a stagflationary undertone to the eurozone economy.

Given it’s relatively self-reliant in energy, the US will likely see prices rise in products refined from crude. That said, prices for gasoline are rising at the pumps. For President Trump, justifying a foreign war at home is hurting his approval ratings.

News that US national debt now exceeds $39trn has brought the cost of the Iran war into sharper focus. It’s growing apace. Seven months ago, it passed $37trn and it may hit $40trn by the time of the US Mid-Term elections in November. Spending from the Covid-19 pandemic and funding conflicts pushed the level up in recent years. Now, White House economic advisers already estimate the cost of the Iran war so far to be around $12bn. This fiscal stumbling block exposes President Trump’s competing priorities of tax cuts, higher defence spending and promises to reduce the debt burden itself. 

The prospect of higher inflation and military spending has pushed up government bond yields and reduced the chances of interest rate cuts, thereby weighing on the US’s fiscal situation. More debt and higher borrowing costs will increase debt interest payments. Net interest payments are now expected to exceed $1trn in 2026 – nearly triple the 2020 level. Around one-in-five dollars the US government receives in income is now spent paying debt interest. Consumers are also likely to feel the pinch as mortgage rates rise and the costs of goods and services increase. The rising cost of living is likely to be a major theme of the UK’s May elections and US Mid-Terms.

• UK retail – Sales fell by 0.4% in February, beating expectations of a 0.7% decline but well below the 2% rise recorded in January. Retailers cited wet weather had weakened demand and that many consumers had brought forward purchases in January to take advantage of seasonal discounts

• Anthropic PBC – The artificial intelligence (AI) company announced that Claude, its AI assistant, is now able to operate a personal computer and complete tasks by opening apps, browsing the web and populating spreadsheets

• Amazon.com, Inc. – The cloud computing division, Amazon Web Services (AWS), revealed plans to develop an AI agent to automate some of its operations following a series of staff cuts. The new AI agents will be deployed in sales, business development and marketing

• Germany – Rising costs and higher inflation expectations led consumer sentiment to fall to its lowest level in more than two years. The Germany GfK Consumer Climate indicator fell to -28 from -24.8 the month before

• Japan – February’s core inflation fell below the Bank of Japan’s (BoJ) 2% target for the first time since 2022, easing to 1.6% from 2% January. The BoJ may yet raise interest rates as policymakers weigh the inflationary impact of the Iran war

• Turkey – The central bank sold around 50 tonnes of gold to buy the Turkish Lira (TRY) to help stabilise the currency. This follows $26bn of foreign currency sales to buy TRY as the currency hit a record low of 44.1 to the US dollar in March

• United Airlines Holdings, Inc. – CEO John Scott Kirby warned that ticket prices may increase by 20% if jet fuel prices stay high due to the Iran war

• US mortgage demand – Treasuries’ continued climb has pushed the average 30-year fixed rate mortgage up to 6.38%. After falling below 6% at the end of February, they’ve been steadily rising, contributing to a 10% drop in mortgage applications

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