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Good morning. Will the fragile ceasefire allow us all to think about something besides war? Well, we have the PCE inflation report this morning and CPI inflation tomorrow; on Monday, bank earnings reports kick off with Goldman Sachs. Hopefully that will be enough distraction. Email us: [email protected].
Reading the ceasefire bounce
The first day of the US-Iran ceasefire featured an attack on Saudi Arabia’s key east-west oil pipeline, the heaviest Israeli air strikes on Beirut in living memory and Iran re-closing the Strait of Hormuz in response. Declaring peace in our time seems a bit premature, then. But markets have concluded that something has changed for the better. The S&P 500 (which hadn’t fallen on President Donald Trump’s comments about destroying Iranian civilisation) rose 2.5 per cent, and is now a per cent or so from where it was when the missiles began to fly:
Long Treasury yields have not returned to the very low level they touched just as hostilities broke out, but they are right where they were in February. Here is the 10-year:
The short end of the rate curve tells a different story. The two-year didn’t move much yesterday, suggesting that the ceasefire might not lower inflation expectations enough to give the Federal Reserve room to cut rates this year (as the market had hoped before the war began):
We need to be a little cautious with the interpretation here; it would be odd if the two-year saw something that the 10-year did not. My guess is that there were too many price cuts priced into short rates before the war began (why would the Fed cut with low unemployment and inflation a percentage point above target?), and the war brought investors back to reality, where they have decided to stay.
Of course, the important thing about the war from the point of view of stocks and bonds is the oil price, which can bring growth down and inflation up. And while the oil price fell hard yesterday, it is still a third above the prewar level:
This is not an easy price to read, either. Oil experts note that even if hostilities were to stop for good today, it will take months for normal flow through the strait to be restored (equipment, insurance and crews all take time to sort out). So the fact that the price is still elevated is broadly consistent with the optimistic tone of stock and bond prices. The markets seem to share the view of Oxford Economics’ Cassidy Ainsworth-Grace, who wrote yesterday that
The Iranian regime appears to be more willing to compromise than markets had priced . . . it is unlikely to agree to peace without extracting a concession, such as maintaining residual influence over the Strait, but stakeholders will likely accept this if it means a durable resumption of traffic. We believe this means that the end of March was the market floor for this year, particularly if the ceasefire holds and the conflict ends.
Unhedged does not have a view on the durability of the ceasefire, but we think the market should still be pricing in some chance of an oil-driven stagflationary snarl, even if that outcome became meaningfully less likely yesterday. But it is hard to find much sign that it is doing so.
The Hormuz bitcoin tollbooth
One of the more interesting developments yesterday was the comment from Hamid Hosseini, a spokesperson for Iran’s Oil Gas and Petrochemical Products Exporters’ Union, that not only will Iran demand tolls from oil tankers passing through the Strait of Hormuz, but the payments will be taken in bitcoin, “ensuring they can’t be traced or confiscated due to sanctions”.
This is a slightly odd statement. One of the key characteristics of bitcoin is precisely its traceability: every transaction on the bitcoin ledger is transparent and permanent. And funds passed along the chain will probably require a transfer into the fiat currency system, if the Iranians are going to use those funds to buy things. The US authorities (if they decide they object to the tolls or want a piece of them) will be watching for those transfers. “The reality Iran faces is that if they want to import anything, they will have to convert [the bitcoin] into real money at some point, and that will almost certainly touch the dollar-based financial system,” the economist Eswar Prasad, author of The Future of Money, told Unhedged.
Ari Redbord, a former Treasury official and assistant US attorney, is global head of policy at TRM Labs, a blockchain intelligence company focused on illicit finance. He confirms that Iran faces serious logistical challenges if it wants to keep the toll funds away from the dollar system:
Crypto is a paradox. The tech allows you to move larger amounts of funds across borders faster than ever . . . but every transaction is traceable, trackable and immutable. The challenge is all you have is an alphanumeric address [on the ledger]. You can see the money go in and the money go out, but not who is moving it. Our job is finding that out.
The point of vulnerability is the “off-ramp” between the crypto system and the traditional financial system. The Iranians “really need to be able to use the funds to buy things, and you more or less have to do that in fiat,” Redbord says. To avoid scrutiny, state actors may attempt to route activity through non-compliant exchanges or over-the-counter brokers, avoiding firms that adhere to know-your-customer laws. It becomes a cat-and-mouse game. At that point, he says, big global money laundering networks that service drug cartels, North Korean hackers and so-called pig butchering scammers often become involved.
None of this, needless to say, suggests that the existence of a Hormuz bitcoin tollbooth would be a validation of bitcoin as an alternative global currency. It continues to look like a terrible option, along all dimensions, for anyone who has the option of operating openly in the fiat system.
One good read
On becoming a meme in Nigeria.
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