Inside Markets — Israeli Air Strikes

US equities are lower in global risk off trade following Israeli air strikes against Iran’s nuclear and military facilities. The worst-case scenario (~$120 Brent) would involve a military strike against Iran’s traditional energy infrastructure followed by Iran closing the Strait of Hormuz.  In our view, this type of action is a tail risk because larger political forces in the Middle East (Saudi, UAE) have strong incentives to keep the conflict contained (transformational economic plans), while closing the Strait of Hormuz would damage Iran’s own economy by cutting off its largest customer (China).

Treasury yields are higher (prices lower) as the spike in crude prices become a good enough reason to book profits following the weekly advance. The fundamental argument is that higher oil prices will have an inflationary impulse on the economy going forward despite this week’s ‘good’ news on inflation. There are also concerns that next week’s updated Fed dot plot could signal fewer than two expected rate cuts this year. Assuming only limited upside in crude prices, Fed policy and bond yields will be dictated by U.S. labor market data. We would expect to see sharply lower bond yields if/when monthly non-farm payrolls fall below +100,000 or when weekly jobless claims rise above +270,000-280,000 (correlated with sub-100,000 payrolls).