One step forward, then two steps back

Overview

► After the enormous relief brought by the announcement of a ceasefire between Iranians and Americans on April 8, this past weekend the prospect of a more lasting agreement seemed to fall apart. Indeed, after the Iranian authorities announced that the Strait of Hormuz had been reopened, the United States refused to lift the military blockade they had put in place. This triggered a cascade of events resembling a renewed escalation. Iranian authorities first reinstated their blockade and fired on two vessels attempting to make the crossing. For their part, the Americans seized an Iranian vessel, and President Trump issued a series of highly belligerent statements against Iran.

►Obviously, these events once again caused oil prices to surge. After reaching a one-month low of USD 87 per barrel (Brent), the price rose back above USD 95 yesterday. Beyond the negative signal that such a high price sends for the global economy, fears of a return to war have resurfaced, notably following remarks by D. Trump, who said he was ready to destroy Iran’s electricity generation infrastructure and all of its bridges, as he had already announced at the time of the ceasefire.

►Despite the fury, a new opportunity for an extension of the ceasefire, or even for a more lasting agreement, will play out tomorrow. Indeed, after contradictory announcements, there should be a new meeting between Iranian and American delegations in Islamabad. It is worth noting that during the previous round of negotiations, despite its failure, a ceasefire was nonetheless achieved. This time, the stakes are certainly higher: the challenge is not only to find common ground and restore trust between the two belligerents, but also to reassure economic actors about the possibility of a path toward the normalization of global oil and gas supply, with the reopening of the Strait of Hormuz.

►We continue to believe that, on both sides, the economic and political incentive to end this conflict is considerable. Nevertheless, the latest developments can only be a cause for concern. A continuation of the conflict, with the risk of higher energy prices or even shortages, would have a very negative impact on the global economy. The idea, sometimes put forward, that the United States would be relatively spared by this war is false.

►Our central scenario continues to be based on a rapid end to the conflict and a normalization of the economic cycle. Nevertheless, the outcome of the negotiations, which will take place from tomorrow until Wednesday evening, when the ceasefire expires, is crucial to validate this scenario. A favorable outcome would confirm our rather constructive view on risk assets.

►At this point, this war is already weighing on short-term growth. The latest economic data, on both sides of the Atlantic, show a clear trend toward disappointment relative to expectations. This is currently more the case in the euro area than in the United States. To reverse this trend, economic momentum needs to improve, which will require a reduction in the energy shock and a return of confidence.

►Similarly, this war will have negative consequences for public finances in many countries that are already facing strained public budget conditions. Indeed, in its latest report, the IMF has urged governments to exercise restraint with regard to potential support measures aimed at cushioning the energy shock. More importantly, the IMF once again emphasized the unsustainable trajectories of public finances in many countries, foremost among them the United States, with public debt expected to exceed 140% of GDP by 2031. In the short term, part of the reduction in the U.S. public deficit achieved last year will be reversed, as the U.S. tax authorities have begun reimbursing USD 166 billion in tariffs that were declared illegal by the Supreme Court last February.

►Today, Kevin Warsh’s confirmation hearing before the Senate will take place, following his nomination by President Trump to take the helm of the Fed next month, when J. Powell’s term as chair comes to an end. The most likely outcome is that he will be confirmed. The main obstacle comes from a Republican senator, T. Tillis, who has already stated that he will not vote in favor of the nomination as long as the legal proceedings against J. Powell, related to the renovation of the Fed’s buildings in Washington, are not dropped. However, for markets, the most important issue will be K. Warsh’s commitment to preserving the independence of the institution. He has always stated that he would adhere to this principle. Nevertheless, in recent years he has been very critical of the Fed, accusing it of overstepping its authority. These comments have always been quite vague and difficult to reconcile with reality. One of his flagship positions is that the Fed should drastically reduce its balance sheet. In the current monetary framework in which the Fed operates, this would be impossible without potentially creating financial tensions that would weaken the U.S. and global economies. That said, it is difficult to see how he could secure the approval of the Board of Governors to pursue such an approach today.