Does an Iran Deal Solve the Inflation Problem?
The much-anticipated Iran deal was finally reached over the weekend, and the market is responding with a strong open Monday morning. U.S. crude futures dropped below $80 a barrel for the first time since March, with WTI at $80.53 and Brent at $83.25, both down more than 4%. Interest rates are lower, gold and the iShares Bitcoin Trust ETF ($IBIT) are higher, and the dollar is weaker. Asia surged overnight with the Nikkei up 5.5% and the Kospi up 5.7%. S&P 500 futures are up about 1%, and Nasdaq futures are up about 1.8%.
The formal signing of the deal is scheduled for Friday, June 19, in Switzerland, with Pakistan serving as mediator. President Trump heads to the G7 in France this week and will seek international support. The terms of the deal have not been fully disclosed and will not be exactly known until the signing, but there is plenty of speculation about some points like the release of Iranian frozen funds.
Does the Iran Deal Solve the Inflation Problem?
This is the primary question that matters for the market in the short run. The longer-term positives of a more stable Middle East are something the market will sort through over months, but right now, the only issue driving the indexes is whether the deal removes enough inflationary pressure to produce a more dovish Fed. The short answer is partially.
The deal removes the active-war premium that has been pushing oil higher for the past four months. That is the most direct piece of the inflation problem, and it will show up immediately in lower CPI numbers. But oil at $80 is still well above its pre-war level. The pre-war baseline was around $72.
The structural damage caused by the war has not been repaired. Oil inventories have dropped to some of the lowest levels since the data began in 2003. Energy infrastructure was damaged in nine countries and the logistics of clearing the Strait of Hormuz and restarting shut-in wells will take time. Insurance costs will be elevated for some time.
This nascent deal removes some of the war premium but it does not fix the war damage.
The other piece of the inflation issue is what is already in the system. May headline CPI hit 4.2% year over year. Producer prices rose 1.1% month over month last week, putting wholesale inflation at 6.5%. Real wages are still falling.
The deal does not undo the inflation that has already happened. That increase in prices is not going to disappear. The question is the pace of future price increases. Prices will keep going up, but how fast?
The pressure on the Fed will be reduced to some degree. Instead of having to rush to hike rates amid supply-driven inflation, it can now argue that the oil supply problem is easing.
The structural inflation built into the system, the hot PPI, the labor market that produced 172,000 jobs in May, and the consumer prices that have been running well above target for years, are not solved by this Iran deal. They will still be major issues when new Fed Chair Kevin Warsh holds his first press conference on Wednesday.
The Fed on Wednesday Is the Real Test of Inflation
The June 17 FOMC meeting is the next major catalyst. Kevin Warsh delivers his first press conference and faces a dilemma. The headline data are hot, but oil, the key component, just turned lower, the labor market is strong, and the political pressure to cut rates is intense.
The market is positioned for a dovish Fed because the Iran deal gives Warsh cover to back off on hikes. A surprise hawkish stance on Wednesday would quickly undo Monday’s bounce and reintroduce the rate concern that drove the early-June selling. A surprise dovish stance could extend the rally meaningfully and confirm that the deal really does change the policy trajectory. The most likely outcome is somewhere in between, which means the press conference language will be the focus on Wednesday afternoon.
The Sell-the-News Risk
The deal has been anticipated for weeks. The market has been rallying into it for that entire period. The indexes are not at the prior highs but they are not far below them either, and the overhead resistance from the early-June peaks is meaningful.
The pattern that has been in place since the early-June selling started was strong opens and weak closes. That pattern produces gains in the morning that get sold by the afternoon, which is the structural signature of a market that is distributing rather than accumulating. Monday is the test of whether the deal is a strong enough catalyst to break that pattern, or whether the rally gets sold into again as the day develops.
The close matters more than the open. A strong close above the morning’s highs would be the first session in a while that breaks the distribution pattern and would suggest the deal really does change the character of the market. A strong close is the promise of sustained upside momentum.
My Strategy
My cash levels stay high, my position sizing stays incremental and my buying continues to be selective and focused on names with their own catalysts rather than chasing the index move. Second-quarter earnings are coming in about a month, and there will be some significant catalysts on the horizon.
The Iran deal is obviously good news, but it has been well-anticipated, and the bullish case has been discounted to a great degree. The Fed on Wednesday and the formal signing on Friday are the events that decide whether the rally extends or fades.
I am inclined to use strength to lighten some positions that have run hard rather than add aggressively. The reactive approach has worked through the past three months of volatility and there is no reason to abandon it now just because the long-awaited catalyst has finally arrived.
At the time of publication, Rev Shark had no positions in any securities mentioned.
