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The War's Impact On Emerging Markets
Among the many economic ripple effects from the war in Iran, the inflation-economic growth balances in developing market economies have been upended. Currencies are plummeting relative to the dollar. William examines economies affected the worst including net energy importers India and Indonesia as well as Japan, where the yen-carry-trade risk has returned. … As net exporters of commodities, Latin American economies are faring much better. Toby sees opportunities for investors in Latin American stocks, particularly those of Brazil and Mexico.
Bond Yields Heating Up
Today, the US launched Project Freedom, deploying 15,000 service members and over 100 aircraft to escort stranded commercial vessels through the Strait of Hormuz. The first two US-flagged merchant tankers were successfully escorted this morning. However, Iran struck the UAE's Fujairah energy hub and a UAE oil tanker and damaged residential areas in Oman. US forces destroyed six Iranian small boats and intercepted multiple missiles and drones. Tehran claimed to have struck a US warship, a claim the Pentagon flatly dismissed. Diplomatically, the two sides remain deadlocked. Trump rejected Iran's latest 14-point peace proposal, which sought an end to the blockade of Iran's ports in exchange for reopening the Strait. Four scenarios are now in play. There could be a prolonged stalemate, with the Strait remaining closed, while the US blockades Iran's ports. That could lead to a second scenario in which the two sides negotiate a deal. That's not very likely given the intransigence on both sides about whether Iran should be allowed to keep its nuclear program. The third alternative is that US forces open the Strait militarily, while continuing to blockade Iran. This could quickly lead to a fourth scenario in which a full-scale war restarts, causing much more damage to energy infrastructure around the Persian Gulf and resumed oil-price climbs. The launch of Project Freedom sent the price of Brent crude as high as $114 a barrel today (chart). That weighed on both the stock and bond markets today. US Treasury yields and mortgage rates have been rising amid the jump in oil prices since the start of the war (chart). The nominal 10-year Treasury bond yield has been pushed higher by the expected inflation rate embedded in the spread between it and the 10-year TIPS yield (chart). Not surprisingly, the 10-year expected inflation rate is highly correlated with the price of crude oil since this price is a significant cost of doing business and therefore has a strong influence on the overall inflation rate (chart). The yield curve has bear-flattened since the start of the conflict (chart). The bond market is discounting higher inflation and a Fed that stays on hold or may even have to tighten. Indeed, the 2-year Treasury yield rose above the federal funds rate (FFR) around mid-March, when the war was raging (chart). It remains above the FFR. Fixed-income investors have given up on expecting the Fed to lower interest rates because the inflation outlook has worsened as the labor market and other economic indicators have improved in recent months. Here are the latest: (1) Factory Orders. New orders surged in March by 1.5% m/m, the largest monthly gain since last November and coming in at triple the pace economists had expected. Leading the way higher have been nondefense capital good orders excluding aircraft (chart). The increase in new orders has been widespread. The AI-infrastructure buildout is plain to see in soaring orders for computers and electronic products (chart). AI has become its own stimulus program for the US economy, with hyperscalers' capital outlays now projected to approach $800 billion in 2026 and climb above $1 trillion by 2027, according to estimates by Morgan Stanley. (2) Business Surveys. The ISM manufacturing PMI registered 52.7% in March, matching the February reading and marking the fourth consecutive month of expansion (chart). April's regional business surveys corroborated the national manufacturing survey.
Consumers Still Doing What They Do Best
Consumer spending is the single biggest driver of US GDP growth, and its remarkable resilience despite lackluster income growth contributes mightily to the resilience of the US economy broadly. Today, Ed and Elias explain why consumer spending has seemed to defy economic gravity and why it should continue to do so. The short answer: our “gen-shaped economy,” shaped by generational dynamics as the Baby Boomers move through life’s phases. As retired Boomers chip away at their massive nest eggs while not earning a paycheck, they’re keeping consumption aloft and the saving rate falling. … Also: Three other consumption tailwinds are worth noting. So is one potential risk to our optimistic spending outlook: a prolonged period of triple-digit oil prices. … And: Dr Ed reviews “Mr. Burton” (+ +).
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