Market Anticipates Positive End to Israel-Iran Conflict After U.S. Involvement Update
Iran seems afraid to risk an escalation that would lead to direct U.S. involvement, leading to a market assumption and big Fed decision.
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While the fighting continues between Iran and Israel, the market is pricing in a positive outcome in the Middle East. Casualties continue to mount as Iran and Israel continue to attack each other, but an optimistic narrative is emerging.
Israel has the upper hand, militarily. Through a combination of traditional military force, intelligence, espionage and even sabotage, Israel has demonstrated the ability to target specific leaders and sites with a high degree of success. Iran, on the other hand, seems to be confirming what many of Academy Securities’ Geopolitical Intelligence Group (GIG) stated back when Iran launched 1,000 or so missiles and drones against Israel: the weapons weren’t as effective against Israel’s Iron Dome and other defenses as feared.
Rather than seeing Israel attacked on multiple fronts, the proxies have been quite quiet. Damage done to the proxies since Hamas attacked Israel on October 7, 2023, has been substantial.
Iran is afraid to risk escalation to the point of direct U.S. involvement. While Iran has managed some strikes into Israel, the missile barrages seem dangerous, but not overwhelmingly so. Would they dare risk bringing the U.S. into more direct involvement? That would seem like a bad idea strategically from Iran, given its performance so far.
The Straits of Hormuz seem likely to remain open. Threats about potentially trying to close this are largely being ignored (and crude prices are slightly lower). Do they have the capability? Maybe, but that could bring the U.S. into the conflict in a more meaningful way. It would also not be surprising if China, via back channels, has messaged its preference to continue receiving Iranian oil.
Also, regime change is on the table. From the messaging Israel is sending, it is clear that it believes there is a potential to kindle a regime change in Iran. We should all assume it has some degree of intelligence giving them the confidence to go ahead with that messaging.
While the Islamic Revolutionary Guard Corps (IRGC) is allegedly still a major force to be reckoned with (we will come back to the word “allegedly” shortly) this would be a major positive development for the region. As the GIG has been pointing out for the past two years, with increasing emphasis, Iran has become the outlier and the “enemy” of the Middle East rather than Israel. Many of the nations want to move on and continue to develop post fossil fuel economies — just look at the deals President Trump struck on his recent trip to the region. One can even wonder if regime change might be easier to accomplish than knocking out all of the nuclear capabilities?
Though anything can still happen while the fighting continues, the optimistic narrative seems plausible and is very positive.
Which brings us to the point where we need to think about further ramifications. Since China, the Chinese military and the possibility of attacking Taiwan come up in so many of our meetings, we cannot help but wonder if China has some doubt about its own military.
Russia turned out to be far less superior in the field than one would have expected on paper. It squandered a massive advantage in equipment early on, and while it continues to pound on Ukraine, it has failed to progress much beyond what it held before this all started.
North Korean troops made headlines by fighting alongside Russians in Ukraine. By all accounts, they had incredibly poor tactics (World War I style charges, leading to their own slaughter). While North Korea has nukes and missiles, and we need to continue to take it seriously, its military seemed lacking in practice (at least, from what we witnessed in Ukraine).
Iran’s “vaunted” missile systems is also an issue. Not to diminish the deaths that have occurred on both sides, but this has not been “shock and awe” levels of performance. While Iran has no air force, nor navy, so to speak, its air defense systems also seemed particularly vulnerable.
China, a year or so ago, had dismissals in its “elite” rocket and missile forces. During the brief altercation between India and Pakistan, the Chinese fighter jets supposedly performed well, but the Chinese anti-air defenses did not (that is the intelligence scuttlebutt that came out of that fighting).
If you are Premier Xi, it seems almost impossible that you aren’t at least a tiny bit worried that your own rapidly-growing military is merely a paper dragon.
Maybe this will encourage China to negotiate more fulsomely with the U.S. on the trade front?
In any case, hopefully, given the recent talks and the focus on rare earths and critical minerals, the U.S. will embrace the policy of "national production for national security," which we touched on time and again as our favorite method for ramping up production in the U.S.
The fighting continues, and there are risks, but what seemed like optimistic outcomes now seem to be the most plausible outcomes.
At this rate, the FOMC meeting might be important, and I continue to expect the market to be surprised by a shift to dovishness from this Fed. I will provide “ahead of the Fed” on Tuesday, as getting it right on the Middle East conflict is the priority.
