The Fed and Robotaxis Outweighing Geopolitics

Ten days ago, after Israeli warplanes first attacked Iranian installations, we wrote a piece about how a major geopolitical event was once again greeted with a relative yawn from the market.  On Saturday night, US warplanes upped the stakes, but stocks recovered after a relatively rocky overnight session and turned higher when US markets opened this morning.  Quite frankly, if oil traders aren’t too concerned about events involving Iran, it is difficult for their equity counterparts to maintain a major case of nerves.

We have frequently asserted that commodity and Treasury markets – not stocks — are the bellwethers for interpreting economic risk when geopolitical events occur.  Commodities prices are laser-focused on supply and demand, while Treasuries are the beneficiary of “flight to safety” trades.  

Since the Middle East dominates global energy production, I was primarily focused upon oil futures last night.  The initial jump of about 5% seemed proportionate with the incremental risk that Iran might harass or otherwise impede tankers using the Strait of Hormuz.  Treasury yields declined modestly as well, reinforcing the notion of risk aversion.  But stocks never really cracked, with ES futures falling by about ½%, but not much further.  As the night wore on, without any overt action from Iran to disrupt oil markets, most financial markets returned to relative normalcy.

Here’s why: Saturday night’s news was highly meaningful geopolitically, but far less so from a market viewpoint.  The reaction once again fit with what we recently wrote:

We have always contended that when push comes to shove, in contrast to commodities and bond investors, equity investors are not particularly concerned with geopolitics. We’re good at assessing how specific events might affect the variables that directly influence stock valuations – revenues, earnings, and cash flows – but far less so when it comes to relatively nebulous events.  A conflict between Israel and Iran could metastasize in all sorts of nasty ways, but quite frankly, the Israeli economy is too small to affect many multinationals’ bottom lines, and Iran has been isolated from the global economy for decades. 

We noted then that unless the Iran situation offered a meaningful reason why those events might adversely affect stock prices – and little outside of an oil shock would do that – then there is little need for investors to change their views on stocks in the short term.  That said, it would be naïve to expect no response from Iran (cyberattacks and terrorism are threats outside of the relatively extreme option of disrupting global oil supplies).  The incremental risk is why we see VIX remain relatively elevated even as stocks are generally higher.

Thus, with no overt rationale for an immediate “freak out”, stock traders focused on the positives.  The rollout of robotaxis in Austin, TX was good for a 10% bounce in Tesla (TSLA) stock, in turn giving a lift to the S&P 500 (SPX) and Nasdaq 100 (NDX) indices.  It is nigh impossible to expect that the initial tests will be profitable, considering that the starting price is $4.20 per ride (ok, we get it) and Waymo is yet to turn a profit in its more extensive operations, but traders are understandably hopeful that this development is a concrete step toward validating the futurism that is baked into TSLA’s lofty valuation. 

More importantly from a macro viewpoint was this morning’s softer rate stance from Fed governor Michelle Bowman.  In a speech this morning, she implied that she would be open to supporting a rate cut as early as July.  Coming on the heels of similar comments on Friday from Fed governor Christopher Waller, it is understandable why markets would respond favorably – especially considering that Ms. Bowman was the only dissenter when the Fed cut rates last September.  In response, short-term interest rates fell sharply, with 2-year notes rates diving by about 10 basis points during the morning. 

Crucially, this was not a flight to safety, but instead a reassessment of the likelihood of rate cuts.  On Wednesday, Fed Funds futures were pricing in a roughly 71% chance of a rate cut in September and just under two cuts by December.  There is now a full cut priced in for September and a 30% chance of an additional cut by December.  (July odds have risen only from about 10% to about 22%, however). 

One thing to keep in mind – things can change quickly.  Concerns about Qatar’s airspace and the potential for an Iranian assault on the US base in that country have risen while I was typing this piece.  We’ll also get two days of Congressional testimony from Chair Powell tomorrow and Wednesday to learn whether he agrees with his colleagues.  Stay tuned to the news!