"If I sit silently, I have sinned." - Mohamed Mossadegh
Most geopolitical risk events are non-events for markets, even if consternation about them is widespread. This is typically the case. It's important always to remember that the market does not care for our emotional experience. Wars, famines, and other disasters that make us lose our composure are simply not perceived by the market. Ultimately, the only thing that matters is the almighty ask and the boisterous bid.
It's important not to think of market catalysts through our individual perspective, colored by our individual experiences and biases, and instead to examine markets through what will cause the sellers to either dramatically outnumber the buyers, or something that can cause a complete absence of buyers. That's what a true top in markets is: when the last buyer has bought and only sellers remain.
This is what causes the forced liquidations and sell-offs that can cause the VIX to spike. And sell-offs like these are more likely to occur during low volume periods. We are in one of the lowest volume periods of the year as August starts, and I think the Iranians have been compelled to act by Israel's brazen attack that resulted in the death of a Hamas leader in Tehran. The effects in markets will be exacerbated by typical seasonal headwinds.
Iran's symbolic show of force months ago after another Israeli assassination was meant to demonstrate a sinister capability. And Israel nearly simultaneously attacked a Hezbollah leader near Beirut. It has antagonized powerful adversaries who will now likely attempt successfully to exert major pain on Israel.
Though it appears neither side wanted an all out war, it appears Israel may have made the calculation that it can win one with the help of a US air defense umbrella so ably demonstrated when Iran launched hundreds of drones against the country months ago. The brazen Israeli strikes against the leaders of two key adversaries on enemy territory have a high probability of provoking a real response that could lead to a high-intensity regional conflict. I don't think Iran will be sending a symbolic demonstration of strength this time, I think it will be out for blood.
This attack empowers hardliners in Hezbollah and in Iran, not to mention stoking support for the Arab cause in the West Bank and Gaza.
This attack severely diminishes the chances for a cease fire which was seeming more likely. In fact, the Hamas official killed was a key figure in cease fire negotiations.
While Israel remains militarily superior to its adversaries on many planes, that doesn't mean Iran and Hezbollah don't possess credible kinetic deterrents.
However, the employment of their deterrents will likely lead to a rapid escalation of the regional conflagration that consensus likely underestimates. Iran could block the Strait of Hormuz.
The market is focused on the Federal Reserve, but given the centrality of the region to oil prices, I think its possible that escalating tensions in the Middle East give Powell motivation to lean more hawkish today than consensus expects.
This in itself could cause a volatility spike since expectations are for a dovish Fed. You'll get some dovish shoots, but the statement is likely to tend toward more hawkish than consensus expects given the rising prospects for a hot war in the Middle East that could raise global commodity prices.
A Middle East War Could End Up Putting Off an Expected Hike
"Hezbollah may decide that in order to restore deterrence with Israel, it needs to conduct a more significant attack that targets civilian and military areas deep inside Israel." -Institute for the Study of War (7/30/24)
No one can tell the future. However, I think there's an elevated risk of a major conflict in the Middle East, and one that potentially results in mass civilian casualties on both sides. Of course, once this grim outcome occurs, the volatility and worsening potential of conflicts escalates out of control quickly.
While Israel made the calculation months ago that the Iranians wouldn't want war even with brazen attacks that violated their sovereignty, these latest violations appear to be establishing a norm that is quite unacceptable to both Hezbollah and the Iranian Theocracy.
I believe consensus is overly focused on positive news from the Fed. I believe the Fed is more focused on the prospect of a Middle East War reigniting inflation, given recent developments, than it is on appeasing the dovish voices. There is still a massive chance it cuts in September, particularly if the war is avoided.
While the chances of war are severely elevated, cooler heads still may prevail. The Iranian regime may be satisfied with another symbolic response, but I think it is highly likely that hardliners have the upper hand in Tehran now and that they are out for blood. And potentially a lot of it.
