Episode Details

The Fed raised rates after all last week. Our expectation of political expediency and therefore a hold pose was set aside by a more pragmatic FOMC fearing persistent and non transitory inflation in the system.

The 10 year US Treasury blew through 5% and the yield curve steepened. Ie the long end rose faster than the short. The implication is a recession or at least an economic slowdown.

Whilst Brent crude declined back below $100 per barrel last night, thanks to expectations of resolutions to be agreed at this week’s UN summit in New York, we are of the view that the reality on the ground is worse than it has been since the start of the conflict with Iran.

The blocking of the Strait of Hormuz resulted in disruption to 20% of the global demand for oil. The escalation in the last 2 weeks by Houthi rebels and Iraqi militias allied to the Iranian regime, has resulted in a further 10% of global demand disappearing from markets. With a 1/3 of global demand now disrupted and the US’s Strategic Petroleum Reserve (SPR) down to lows not seen since 1982, we see significant upside risk to the oil price.

With Brent Futures contracts exchanging hands at $120+ per barrel and the northern hemisphere heading into winter, the inflationary impact cannot be underestimated.

A $130 Brent price implies a $5+ gasoline price in the US, significantly above the current level and more than double pre-war levels. This would contribute 0.75-1% to inflation. Add in the impact of logistics cost increases and jet fuel, and the impact is even more severe.

Inflation of 4.5%+ implies a further 50bps of Fed rate hikes over the next 5-6 months leading to a slowdown in US GDP toward 1-1.5%. 

Furthermore, the rate increases would bring already insipid capital expenditure (ex AI spend) to a virtual halt and would severely hamper the housing market facing 30 year mortgage rates of 7.5-8%.

The implication for risk-assets is clearly not a positive one. We remain sanguine over the long-term positioning in equities. We are in the midst of one of the most consequential Industrial/Digital revolutions that mankind has hitherto been exposed to. There will be major winners and to a large extent we can already see who those may be.

However, near-term, the inflationary impact of higher energy prices and no discernible off-ramp for the Mid-East war will only raise investor concern and angst leading to higher volatility and near-term market correction.

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