Financial Markets’ Iran Delusion

A restrained reprisal by Iran following the assassination of its top military commander has led markets to conclude that the latest threat to the global economy has been removed. But just because Iran and the United States have so far avoided a full-scale war does not mean that markets are out of the woods.

Nouriel Roubini

roubini136_Wang YingXinhua via Getty_stock market

LONDON – Following the United States’ assassination of Iranian Quds Force commander Qassem Suleimani and Iran’s initial retaliation against two Iraqi bases housing US troops, financial markets moved into risk-off mode: oil prices spiked by 10%, US and global equities dropped by a few percentage points, and safe-haven bond yields fell.

In short order, though, despite the continuing risks of a US-Iran conflict and the implications that it would have for markets, the view that both sides would eschew further escalation calmed investors and reversed these price movements, with equities even approaching new highs.

That turnabout reflects two assumptions. First, markets are banking on the fact that neither Iran nor the US wants a full-scale war, which would threaten both the Iranian regime and US President Donald Trump’s re-election prospects. Second, investors seem to believe that the economic impact of a conflict would be modest. After all, oil’s importance as an input in production and consumption has fallen sharply since past oil-shock episodes, such as the 1973 Yom Kippur War, Iran’s 1979 Islamic Revolution, and Iraq’s 1990 invasion of Kuwait.

Moreover, the US itself is now a major energy producer, inflation expectations are much lower than in past decades, and there is little risk of central banks hiking interest rates following an oil-price shock.

Both assumptions are clearly flawed. Even if the risk of a full-scale war may seem low, there is no reason to believe that US-Iranian relations will return to the status quo ante. The idea that a zero-casualty strike on two Iraqi bases has satisfied Iran’s need to retaliate is simply naive.

Those Iranian rockets were merely the first salvo in a response that will build up as November’s US presidential election approaches. The conflict will continue to feature aggression by regional proxies (including attacks against Israel), direct military confrontations that fall short of all-out war, efforts to sabotage Saudi and other Gulf oil facilities, impeded Gulf navigation, international terrorism, cyber attacks, nuclear proliferation, and more. Any of these could lead to an unintentional escalation of the conflict.

Moreover, the Iranian regime’s survival – its leaders' top priority – is more threatened by an internal revolution than by a full-scale war. Because an invasion of Iran is unlikely, the regime could survive a war (despite a very damaging aerial bombing campaign) – and even benefit as Iranians rally around the regime, as they briefly did in response to the killing of Suleimani.

Conversely, a full-scale war and the ensuing spike in oil prices and global recession would lead to regime change in the US, which Iran badly desires. So, Iran not only can afford to escalate, but it has all the incentives to do so, initially through proxies and asymmetric warfare, to avoid provoking an immediate US reaction.

The assumption about what a conflict would mean for markets is equally mistaken. Though the US is less dependent on foreign oil than in the past, even a modest price spike could trigger a broader downturn or recession, as happened in 1990. While an oil-price shock would boost US energy producers’ profits, the benefits would be outweighed by the costs to US oil consumers (both households and firms).

Overall, US private spending and growth would slow, as would growth in all of the major net-oil-importing economies, including Japan, China, India, South Korea, Turkey, and most European countries. Finally, although central banks would not hike interest rates following an oil-price shock, nor do they have much space left to loosen monetary policies further.

According to an estimate by JPMorgan, a conflict that blocks the Strait of Hormuz for six months could drive up oil prices by 126%, to more than $150 per barrel, setting the stage for a severe global recession. And even a more limited disruption – such as a one-month blockade – could push the price up to $80 per barrel.

But even these estimates do not fully capture the role that oil prices play in the global economy. The price of oil can spike much more than a basic supply-demand model would suggest, because many oil-dependent sectors and countries will engage in precautionary stockpiling. The risk that Iran could attack oil production facilities or disrupt major shipping routes creates a “fear premium.”

Hence, even a modest oil-price increase to $80 per barrel would lead to a sustained risk-off episode, with US and global equities falling by at least 10%, in turn, hurting investor, business, and consumer confidence.

It is worth remembering that global corporate capital spending was already severely dampened last year, owing to worries about an escalation in the US-China trade and technology war and the possibility of a “hard” Brexit. Just as these risks – that is, the “option value of waiting” – were receding, a new one has emerged.

Leaving aside the direct negative impact of higher energy prices, fears of an escalating US-Iran conflict could lead to more precautionary household saving and lower capital spending by firms, further weakening demand and growth.

Moreover, even before that risk emerged, some analysts (including me) warned that growth this year might be as tepid as growth in 2019. Markets and investors had been looking forward to a period of easier monetary policies and an end to the tail risks associated with the trade war and Brexit.

Many market watchers were hoping that the synchronized global slowdown of 2019 (when growth fell to 3%, compared to 3.8% in 2017) would end, with growth approaching 3.4% this year. But this outlook ignored many remaining fragilities.

Now, despite Wall Street’s optimism, even a mild resumption of US-Iran tensions could push global growth below the mediocre level of 2019. A more severe conflict that falls short of war could increase oil prices to well above $80 per barrel, possibly pushing equities into bear territory (a decrease of 20%) and leading to a global growth stall. Finally, a full-scale war could drive the price of oil above $150 per barrel, ushering in a severe global recession and a fall of over 30% for equities markets.

While the probability of a full-scale war remains low for now (no more than 20%, in my view), the chances of simply returning to the pre-assassination status quo are even lower (say, 5%).

The most likely scenario is that the situation escalates into a new grey area (indirect conflict and direct clashes falling short of war) that would drive up the risk of a full-scale war. At that new baseline, the market’s current complacency will look not just naive, but utterly delusional.

The risk of a growth stall or even a global recession is now much higher and rising.

Nouriel Roubini, Professor of Economics at New York University's Stern School of Business and Chairman of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank. His website is

Federal Reserve’s embrace of higher inflation is ‘momentous’ for markets

Funds pile into gold, commodities and inflation-protected bonds as hedges for price rises

Jennifer Ablan

Everything worked in 2019. US stocks, junk bonds, silver, oil, bitcoin and even Greece-focused exchange traded funds posted stunning gains, boosted by easy central bank policies.

Now new risks lurk, as the US Federal Reserve continues to keep interest rates low and pursue monthly liquidity injections, as well as purchases of Treasury bills at a similar magnitude as previous rounds of quantitative easing. Such efforts have helped to send nearly every asset class into “bubbly” territory.

But a growing band of voices on Wall Street is warning of a possible consequence of this ever-looser monetary policy: inflation, which could dominate headlines this year for the first time in many.

Jeffrey Gundlach, chief executive of DoubleLine Capital, said it was a remarkable day for financial markets in late October, when Fed chair Jay Powell said he would need to see a “really significant move up in inflation that’s persistent, before we would even consider raising rates to address inflation concerns”.

For Mr Gundlach, whose firm manages $150bn in assets, the key word was “persistent.” He described it as “momentous” that Mr Powell was “now one of the leading inflation cheerleaders in the system. Higher inflation is now the goal of the Federal Reserve chairman. Can’t people see what a big shift this is?”

Worrying about inflation would certainly make a reversal from the past decade or so, when market watchers have been more bothered about deflation. Central banks have pulled out the stops to avoid sinking into the low-growth, low-inflation mire of “Japanification”.

The Fed cut interest rates three times last year, taking its target range for short-term borrowing costs to 1.5 per cent to 1.75 per cent.

The US central bank has a dual mandate of stable prices and maximum sustainable employment, “but unemployment is at a 50-year low, so why would they cut rates three times in three months?” said Richard Bernstein of Richard Bernstein Advisors. “It must be their concerns about deflation. Or put another way, not enough inflation.”

Mr Bernstein and Mr Gundlach note that Mr Powell’s push for more inflation is coinciding with moves by Donald Trump, US president, to relax fiscal constraints. The US government’s annual budget deficit swelled to $984bn in fiscal 2019, the most in seven years, as a drop in tax revenues coincided with higher military spending. The deficit is expected to top $1tn this year, theoretically feeding inflation.

At the same time, the effects of the long trade war with China may work their way through into higher consumer prices. The reason the US has not seen more inflation so far from tariffs is that companies are absorbing extra tariffs and accepting the squeeze on their margins. “That’s unlikely to continue in 2020,” said Mr Bernstein.

As a result, Mr Bernstein said his firm, which oversees $9.3bn of assets, has big positions in Treasury inflation-protected securities, or Tips. Such bonds, which pay investors a fixed interest rate as the bond’s par value adjusts with the inflation rate, are the “most straightforward way” to safeguard portfolios from inflation, said Kathy Jones, chief fixed income strategist for Charles Schwab.

Mr Gundlach also favours Tips as well as gold, commodities and emerging market assets, which tend to benefit from a weaker dollar, knocked down by inflation. He said a lower dollar was his highest-conviction trade for the year.

“We’ve suggested we are revisiting That ’70s Show, but not the late-’70s,” said Mr Bernstein, referring to the TV sitcom. “The inflation spirals of the ’70s didn’t start with everyone worried about inflation.”

Some parts of the market are catching on. Investors poured $208m into US-based Tips funds in the week ended January 15, according to Lipper data. That was the fifth consecutive week of inflows.

The softening dollar, meanwhile, is unleashing flows into commodity-linked funds, according to Jason Bloom, senior director of global ETF strategy and research at Invesco. He said such funds serve as a “powerful inflation hedge”.

Others are also piling into gold, the classic inflation hedge. Bridgewater Associates, the world’s largest hedge fund with $160bn in assets under management, sees gold prices, currently about $1,550 an ounce, eventually moving beyond $2,000 in an environment of lower rates and the Fed’s embrace of higher inflation.

The plaudits paid to former Fed chair Paul Volcker, who died late last year, focused on his victory over inflation in the 1970s.

His tenure demonstrated that inflation, once unleashed, is not easily tamed. It is understandable that investors are getting nervous about looser talk.

Persistent stimulus has kept global growth on track

Luckily, policymakers have believed their eyes rather than their theories

Martin Sandbu

Jerome Powell, chairman of the U.S. Federal Reserve, left, and Mark Carney, governor of the Bank of England (BOE), walk the grounds during the Jackson Hole economic symposium, sponsored by the Federal Reserve Bank of Kansas City, in Moran, Wyoming, U.S., on Friday, Aug. 23, 2019. Powell said the U.S. economy is in a favorable place but faces
Jay Powell, US Federal Reserve chairman, left, and Mark Carney, Bank of England governor, during the Jackson Hole summit in Moran, Wyoming, US, in August © David Paul Morris/Bloomberg

“The right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump; but in abolishing slumps and thus keeping us permanently in a quasi-boom.”

Thus wrote John Maynard Keynes in 1936. More than 80 years on, his insistence that governments should continue to stimulate demand even in a prolonged upswing is newly relevant.

The long, slow recovery from the 2008 financial crisis shows how concerns that demand stimulus had exhausted its purpose and should be dialled back have been at best premature.

So what have we learnt? The lessons are remarkably similar in all advanced economies.

First, demand stimulus works.

That simple observation faces surprising resistance. But those who reject stimulus because the economy is still in the doldrums and inflation below target have it the wrong way round.

The fact is that a persistent expansionary policy — monetary stimulus everywhere, and fiscal stimulus in the US and a few other places — has kept growth on track well beyond the length of typical economic recoveries, and more stimulus has tended to go with more growth.

This has pushed unemployment down and created more jobs than observers thought was safely possible.

The “Phillips curve” that warns of inflation rising when labour markets become too tight has been quiescent.

Second, the longer demand keeps expanding, the greater the benefits for the least fortunate.

Those on the margins of the labour market are typically hurt first and worst in a downturn.

Conversely, only when the economy is kept in Keynes’s “quasi-boom” does it bring them towards acceptable levels of unemployment and wage growth.

In the US, according to researchers associated with the US Federal Reserve, “when the unemployment rate of whites increases by 1 percentage point, the unemployment rates of African Americans and Hispanics rise by well more than 1 percentage point, on average”.

In a recent paper, they found that when labour markets are particularly tight, this extra advantage for marginalised groups becomes even stronger.

In this sense, aggressive demand stimulus becomes more, not less, beneficial the longer it goes on.

We can see this phenomenon in many of the numbers and stories that describe the current state of our economies.

In the US and the UK, recent wage growth has been strongest for those paid the least.

In much of Europe, more of the population has a job than ever before.

Anecdotes abound about those previously given up as hopeless cases — former drug addicts and ex-prisoners, for example — now being not just hired, but trained to earn their keep by employers struggling to fill vacancies.

We are entitled to hope for a third lesson: that the historical pattern of productivity increasing in an upswing will also come through this time.

The reason for procyclical productivity is that robust demand growth creates incentives for businesses to do more with the same resources once it becomes difficult to expand by just hiring more.

We have been lucky in that many policymakers, especially central bankers, have been more willing to believe their eyes than their theories.

They have seen their policies working for longer than expected. They have noted the positive results — often highlighting the lack of inflationary pressures, the benefits of driving employment higher for those on the margins, and the possibility that supply capacity adjusts to satisfy demand pressures.

Because of this sensitivity to economic reality, the end of demand stimulus has been postponed many times.

Without it, more policymakers would have caused unnecessary slowdowns or downturns — as the eurozone did by tightening fiscal and monetary policy in 2011.

But avoiding unforced mistakes is not enough for sound policymaking. At a minimum, the experiences of the past decade call for a much more tolerant attitude to stimulus, whether from finance ministries or central banks.

Better still would be to incorporate this data formally in the formulation of policy targets — whether central banks’ mandates or rules for government budgets.

In practice, this could mean at least three things.

One would be to increase the burden of proof for scaling back stimulus on the grounds that the economy had reached full capacity.

That would avoid premature tightening — and the subsequent need to loosen.

Another would be to shift the focus from how the economy performs on average to how it performs for those on its margins.

All-economy (un)employment and inflation rates could be complemented by explicitly taking account of labour market and wage performance for vulnerable groups, trading off higher tolerance for overall inflation risk against greater expected benefits for those often left by the wayside.

Third, the effect of demand pressure on productivity growth could be explicitly included in forecasts.

Such steps could introduce an inflationary bias — but only if there was no risk of leaving unused economic capacity on the table.

But as the past few years have shown, that risk is real.

In the 1980s, economic theory concluded that responsible macroeconomic policy required policymakers who were more hawkish than voters.

Today, we need the opposite.

Was Killing Suleimani Justified?

At a press conference following the US drone strike that killed Iran's top military commander and several others, a senior State Department official burst out: “Jesus, do we have to explain why we do these things?” In fact, the international rule of law depends on it.

Peter Singer

singer179_ATTA KENAREAFP via Getty Images_iranprotestsoleimani

MELBOURNE – On January 3, the United States assassinated Qassem Suleimani, a top Iranian military commander, while he was leaving Baghdad International Airport in a car with Abu Mahdi al-Muhandis, an Iraqi leader of Kata’ib Hezbollah, an Iran-backed militia. All the occupants of the car were killed.

The next day, at a special press briefing, an unnamed senior US State Department official said that Suleimani had been, for 20 years, “the major architect” of Iran’s terrorist attacks and had “killed 608 Americans in Iraq alone.” He added that Suleimani and Muhandis had been designated as terrorists by the United Nations, and that “both of these guys are the real deal in terms of bad guys.”

In 2003, US intelligence about Iraq’s supposed possession of weapons of mass destruction was completely wrong.

Those errors led to the invasion of Iraq, which cleared the way for the involvement of Iran and Suleimani in the country.

But let’s assume that this time the facts are as the US administration says they are.

Was the double assassination ethically defensible?

We can begin with the presumption that it is wrong to take human life.

President Donald Trump won’t deny that. A year ago, for example, he said: “I will always defend the first right in our Declaration of Independence, the right to life.” Trump was addressing his remarks to anti-abortion campaigners, but a right to life that applies to fetuses must also apply to older humans.

Is there an exception for “bad guys,” though?

Again, to keep the argument as straightforward as possible, let’s assume that the right to life protects only innocent humans. Who is to judge innocence? If we favor, as Americans often say they do, “a government of laws, not of men” there must be a legal process for deciding guilt. Since 2002, the International Criminal Court has sought to apply that process globally.

The ICC has had some notable successes in prosecuting perpetrators of war crimes and crimes against humanity, but the court’s scope is limited, and its reach has not been helped by the refusal of the US to join the 122 other countries that have accepted its jurisdiction.

In the wake of Suleimani’s assassination, Agnès Callamard, a Special Rapporteur on extrajudicial, summary, or arbitrary executions at the Office of the UN High Commissioner for Human Rights, noted that there is no oversight of targeted killings carried out beyond a country’s borders.

The Executive simply decides, without any legal due process or approval by any other branch of government, who is to be killed.

Accepting such an action makes it difficult to find any principled objection to similar killings planned or carried out by other countries. That includes the 2011 “Cafe Milano Plot,” supposedly masterminded by Suleimani himself, in which Iranian agents planned to kill the Saudi ambassador to the US while he lunched at a well-known restaurant in Washington, DC.

The only thing the US can say in defense of its assassinations is that it targets really bad guys, and the Saudi ambassador was not such a bad guy. That puts the rule of men above the rule of law.

The other justification that the Pentagon offered for the killing referred vaguely to “deterring future Iranian attack plans.”

As Callamard pointed out, this is not the same as the “imminent” attack required to justify acting in self-defense under international law. She also noted that others were killed in the attack – reportedly, a total of seven people died – and suggested that these other deaths were clearly illegal killings.

A careful reading of the transcript of the January 3 press briefing, held by three unidentified senior State Department officials, reveals the Trump administration’s real thinking.

In response to repeated questions about the justification of the assassination, one official compared it to the 1943 downing of a plane carrying Japanese Admiral Isoroku Yamamoto, who was visiting Japanese troops in the Pacific – an incident that occurred in the midst of war, more than a year after the Japanese attacked Pearl Harbor.

Another official said: “When I hear these questions it’s like you’re describing Belgium for the last 40 years. It’s the Iranian regime. We’ve got 40 years of acts of war that this regime has committed against countries in five continents.”

At one point, the official who had compared the assassination to the killing of Yamamoto burst out: “Jesus, do we have to explain why we do these things?”

If senior State Department officials believe that the US is engaged in a just war with Iran, as it was with Japan in 1943, the killing of Suleimani makes sense.

According to standard just war theory, you may kill your enemies whenever you have the chance to do so, as long as the importance of the target outweighs the so-called collateral damage of harm to innocents.

But the US is not at war with Iran.

The US Constitution gives Congress the sole authority to declare war, and it has never declared war on Iran. Speaker of the House Nancy Pelosi suggested that congressional leaders should have been consulted on the plan to kill Suleimani. If it was an act of war, she is right.

If, on the other hand, the killing was not an act of war, then, as an extrajudicial assassination that was not necessary to prevent an imminent attack, it was both illegal and unethical.

It risks severe negative consequences, not only in terms of escalating tit-for-tat retaliation in the Middle East, but also by contributing to a further decline in the international rule of law.

Peter Singer is Professor of Bioethics at Princeton University and founder of the non-profit organization The Life You Can Save. His books include Animal Liberation, Practical Ethics, The Ethics of What We Eat (with Jim Mason), Rethinking Life and Death, The Point of View of the Universe, co-authored with Katarzyna de Lazari-Radek, The Most Good You Can Do, Famine, Affluence, and Morality, One World Now, Ethics in the Real World, and Utilitarianism: A Very Short Introduction, also with Katarzyna de Lazari-Radek. In 2013, he was named the world's third "most influential contemporary thinker" by the Gottlieb Duttweiler Institute.

The Kenya Attack and Soleimani’s Killing

By: Hilal Khashan

While the world was still reeling from the death of Iranian Gen. Qassem Soleimani, an attack occurred in Kenya against U.S. and Kenyan military forces.

In the early hours of Sunday, fighters with Somalia-based terrorist group al-Shabab overran the Manda Bay Airfield. The airfield is part of Camp Simba, a key military base for Kenyan-U.S. counterterrorism operations, located in Lamu County near the border with Somalia.

The attack was the al-Qaida-linked group’s first on U.S. forces in Kenya and lasted several hours before the attackers were repelled. U.S. and Kenyan officials said the attack resulted in the deaths of three Americans (one soldier and two contractors) and damaged six civilian aircraft operated by contractors.

A Kenyan police report obtained by the Associated Press indicated the destruction was more extensive, saying the attackers destroyed two fixed-wing aircraft, a U.S. Cessna and a Kenyan Cessna, along with two U.S. helicopters and several U.S. vehicles. According to al-Shabab, there were 17 U.S. casualties as well as nine Kenyan soldiers killed and seven aircraft destroyed.

At first glance, the attack does not necessarily register as significant. Al-Shabab has carried out frequent attacks in Kenya since 2011, when Kenya sent troops to Somalia to help fight the group.

Over the past two years, the United States has stepped up its airstrikes against al-Shabab targets, to which al-Shabab responded with an uptick in attacks against Kenyan military and civilian targets. But until now, the group has avoided U.S. forces.

This fact plus the timing and global context suggest the attack may be tied to other, more significant events in the neighboring Middle East and therefore worth more consideration.

Al-Shabab said the Kenya attack was part of a pro-Palestinian jihadist campaign that the group joined back in 2019, but there are reasons to think it may have been retribution for Soleimani’s death.

At this point the evidence is weak, but it appears the attack was hastily organized and poorly executed.

The weapons used were not particularly sophisticated, and the equipment that was damaged – going by the more detailed U.S. report – will not affect the ability of the United States to conduct its counterterrorism operations. The main objective appears to have been to make headlines.

The assailants failed to force their way into the base, and five of them were killed.

Indirect mortar fire inflicted the U.S. and Kenyan casualties, and the aircraft were reportedly damaged by fuel tank fires. The entire episode was concluded within a couple of hours.

It also may not be a coincidence that the attack comes just days after Soleimani’s killing. It’s true that al-Shabab’s attacks in Kenya are frequent, but this is the first time the group has targeted a U.S. base in the country.

Soleimani’s death provided not only a potential motive for an anti-American attack but also the opportunity to strike a U.S. target while the U.S. military was focused on the threat of reprisal attacks closer to Iran – in Iraq or Saudi Arabia, for example – as well as on troop deployments in the Middle East.

Finally, it is noteworthy that al-Shabab claimed that it attacked the military base for the sake of "al-Quds" (Jerusalem), which is similar rhetoric to that used by the Iranians to legitimize previous operations of Soleimani, who commanded Iran’s elite Quds Force.

Though the Islamic Revolutionary Guard Corps and al-Shabab belong to different branches of Islam, the traditional Sunni-Shiite divide between the two groups is not insurmountable, and indeed the two have economic ties.

Al-Shabab exports Somali charcoal, which is famous for its quality, by boat to Iran, where it is repackaged and sold as an Iranian product. Al-Shabab needs funds to cover its expenses, and the Iranians have always been eager to cooperate even though al-Shabab is Sunni.

This is not the first instance of the IRGC crossing the religious divide with other end goals in mind. Hamas works with the Iranians despite their distinct ideological differences, which became obvious after the inception of the Syrian uprising in 2011.

Business transactions and political ideology are two separate matters.

The full range of implications of Soleimani's killing has yet to fully play out and be understood.

In the case of the Kenya attack, the timing, target, poor execution and al-Shabab's rhetoric and economic links to the IRCG are enough to raise the question of a possible link between the two, which would indicate a level of internationalization of the conflict.

Unfortunately, that is all we have to go on at the moment, and no firm conclusions can be drawn.

But the killing of Soleimani was a significant event, and we must be alert for potential ramifications not just in the immediate neighborhood.