Iran and the Warning Shot
The kinetic side of the war with Iran looks nearly over. There is no desire to go back in. Announcements came to put people back into embassies in the Gulf states, a move to calm things down and keep Iran in line.
Treasury Secretary Bessent, in "Operation Economic Outcast," stopped short of firing off secondary sanctions and instead sent a warning signal aimed mainly at China, giving Iran time to correct course. This approach does not work unless the U.S. goes hard after China, and I do not think it will.
You cannot squeeze Iran economically without pressuring China. China responded overnight, saying it would retaliate. Its main weapon is rare earths and critical minerals - specifically the processed and refined versions, where China controls about 90% of that market. That is the big Achilles heel right now, so the U.S. will be very reluctant to push hard. China could also dump Treasuries, though that would hurt itself too, and that risk is on everyone's mind.
Other targets are complicated. Turkey allegedly does business with Iran, but it is a NATO ally, so how hard can it be pressed? Trump seems to be trying to get closer to Kim Jong Un, so North Korea is off the table too. The result will likely be slow, messy, and largely ineffective.
Oil Risks
Oil did not move on the warning shot. If secondary sanctions actually trigger, especially on China ahead of a Xi-Trump summit, oil has to rise again as Iran likely lashes out. The bigger fear now is Iran hitting Gulf state infrastructure rather than attacking ships in the strait. Ukraine continues to hit Russian infrastructure as well.
Oil demand is very tight and diesel is costly. Two things worry me most. China held a billion barrels in storage early in the war and was not a big buyer on the open market; now it is becoming a big buyer, which pushes prices up. The U.S. Strategic Petroleum Reserve sits under 300 million barrels, and there are questions about how far it can be drained. About 100 million barrels were released early on, and doing that again may not be possible. The best outcome now is to smooth this over and move on.
The Bond Market and Global Supply
Druckenmiller, writing in the Wall Street Journal, called Bessent's plan to buy Treasuries a mistake. I think yield curve control is coming at some point. Since the global financial crisis, the government has slid steadily toward more involvement - QE, Operation Twist - so buying Treasuries is not some new trick. Whether it succeeds is unclear.
My concern is that Bessent frames this around bond vigilantes and internal U.S. issues, which are only part of the story. The deficit is rising and little is being done. Issuance is rising. Interest costs are rising. What the argument misses is that global supply of debt is rising sharply. Every country is now spending more on defense and infrastructure, so sovereign nations across the board are selling more debt. The Middle East, once a big buyer of U.S. debt, has less money to do so. On top of that, the AI or compute trade brings huge corporate issuance. This is far more about global debt supply than a U.S.-specific problem.
The only way this works aggressively - and the point at which I would fully agree - is a "federal Operation Twist." The Fed has about $450 billion of Treasuries maturing in a year. If it empowered itself to sell those and buy long-dated bonds, that would create a big move. Otherwise this fizzles.
A report suggests tapping the Treasury General Account (TGA). It normally runs about $750 billion and holds $950 billion now, so a couple hundred billion could be freed up. But corporate issuances from names like Google (GOOGL) or Amazon (AMZN) come in at $20, $30, $40 billion each with no end in sight, so this is a drop in the bucket against global supply.
Treasuries Getting Crowded Out
Investment-grade corporate issuance is competing directly with Treasuries, a point Fed's Bostic made last week. Bostic believes the U.S. can grow its way out of the $4 trillion problem, but that sits in tension with the Fed's inflation fight, since rate hikes and cuts are blunt tools.
The signals are mixed. The U.S. is meeting Xi and wants good trade deals, but being tough on Iran forces being tough on China. New sanctions are starting with China and Canada. Yet building out data centers and AI would benefit from cheaper steel and aluminum than are available now. Growing out of this will be a struggle.
I recommend clients go long high-quality compute bonds versus Treasuries. Treasuries are generic; compute issues offer a nice big spread from companies with good corporate governance. Take the extra spread. Treasuries are getting crowded out, and that is simply how things are.
Inflation Data and Rate Policy
To bring yields down, the key is fixing the data. Warsh's focus on a data task force is the right move. A lot of the data looked at is garbage. Measures like Truflation, and even the Fed's own real-time rent index, ran much higher than CPI in 2020 and 2021, meaning inflation was massively understated then. Right now inflation is being overstated.
Hikes should come off the table. The two biggest pressures on inflation are the war in Iran, which hikes cannot stop, and the compute buildout. Companies chasing 20x or 50x returns will not slow their debt issuance over 50 basis points. The economy should run a little hot to keep growth going, and rates should maybe even be cut. That is the only way to generate growth.
The Fed's Reaction Function
Many say Jackson Hole this week is critical for restoring Fed credibility, and that credibility comes from signaling the reaction function rather than being hawkish or dovish. The market is watching for that, but the market is wrong. The real question is which data the Fed pays attention to and how it weights that data. The message is already clear: the Fed thinks inflation is lower than the official data shows. Market participants keep ignoring this, frustrated by it.
Jobs data, despite low unemployment, does not look as strong. The Fed is set to push back on a rate hike. The market has blinders because it has done things one way for 20 years, and demanding a "reaction function" is a copout. There is a new set of data, and how it gets treated will be slightly different. The market will come around to my view that there are no hikes.
Midterms and Investment Positioning
The big savior for President Trump would be a good resolution somewhere involving regime change, which could shift the polls, currently running the other way. Picking another tariff fight with Canada does no good now.
For investors, I am slightly underweight the compute side - that trade is overdone. I really like energy globally. Every country will follow what Academy Securities calls "pro-sec," production for security, harnessing its own energy and resources better. You cannot be a green economy and a real economy at the same time right now; you must pick one. Canada and other countries should choose the real economy and push the green agenda out 10, 20, 30 years. It remains a real agenda, but self-sufficiency comes first. The same applies to Europe and Australia.
Australia announced its first new refinery in 60 years, a sign of what will happen globally as countries move to protect themselves. This creates big opportunities to invest globally in anything tied to rebuilding and harnessing energy and natural resources. Australia is also working closely with the U.S. on some of this.
