US Equities Dragged Into Global Selloff as Iran Crisis Escalates
Summary
- Oil prices have surged past $100 per barrel, with morning spikes reaching $125, fundamentally altering the macroeconomic landscape and creating a global supply shock.
- The previously held belief that US equities were insulated from global volatility due to a strong US dollar has evaporated.
- Treasury yields are climbing aggressively as the prospect of near-term Federal Reserve interest rate cuts drops to zero.
- A subsequent jump in consumer inflation is expected globally, which may force central banks to consider rate hikes instead of cuts, despite any soothing rhetoric they attempt to provide.
Trade Ideas
The significant change over the weekend is the fact that oil prices are now above $100 rather than below, and they're quite likely going to stay there for some time as well. Sustained high crude prices directly increase the revenue and profit margins of oil producers and energy sector equities. In a supply-shock environment driven by geopolitical escalation, energy companies become the primary beneficiaries of the geopolitical risk premium being priced into the physical commodity. Long major energy producers and the broader energy sector as they capture the upside of sustained triple-digit oil prices. The G-7 successfully coordinates a massive strategic petroleum reserve release, or central banks engineer a severe demand-destroying recession that crashes oil consumption.
Treasury markets yields climbing there aggressively. There is zero chance that the Federal Reserve can constitute an interest rate cut in the near term. Bond prices move inversely to yields. With inflation expected to jump due to the energy shock, the Fed cannot cut rates and may even have to resume hiking. This macro environment forces long-duration bond yields higher, causing the underlying bond prices to fall significantly. Short long-duration treasuries as rising inflation expectations and hawkish monetary policy destroy bond capital values. A sudden, severe economic contraction causes a flight to safety into US Treasuries, driving yields back down and prices up regardless of inflation.
Rather than US equities being somehow on the edge of all of this, they're being dragged right into the centre of it. And it would be very surprising if the US market can withstand this onslaught. The combination of an energy shock, rising inflation, and aggressively climbing treasury yields compresses equity valuation multiples. The previous safe haven status of US stocks is broken, meaning capital will flow out of broad indices as risk-off sentiment takes over and profit margins are squeezed by input costs. Short broad US equity indices as they re-price for higher-for-longer inflation and the removal of near-term rate cut expectations. Federal Reserve speakers successfully talk down the panic, or the geopolitical crisis de-escalates rapidly, causing a sharp relief rally in risk assets.
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