The “Ceasefire” Won’t Save The Economy

Feels pretty close to script, more or less. You know, the president has gone down this path in other ways, and when push comes to shove, when markets start to react, when stock prices are down, when interest rates are up, in this case, when oil prices are up, he figures out a way to pivot, to stand down and to declare victory and hopefully move on. And if you know, this go-around, that's been more difficult than, you know, with other similar events. Greenland comes to mind most recently. This one's been more difficult just because of the Iranians' leverage over the strait. But nonetheless, that feels like where we're headed here. And that's kind of sort of what I think markets have been anticipating. You know, if you look at stock prices, for example, as a benchmark, you know, even at the worst of the angst around what was going on in the Middle East, they were down on the S&P 5 to 10%. So, not even a, you know, typical correction. So, I think investors were expecting the president to do something like this. And in fact, that's now what he's done. Now, clearly, more script to be written here. We'll have to see how this plays out. You know, hard to imagine that this is all going to go forward without any difficulty. It feels like there's more problems dead ahead, but we'll see. But this so far feels kind of sort of what investors have expected. It's close to, as I said, pretty much sticking to the script.

Yeah, I think prices are permanently higher. I mean, when I say permanent, nothing's permanent, but at least in the foreseeable future, this year, next year, the year after. You know, there's no going back to the 60, 65 bucks a barrel we were paying before all this mess. You know, there's the points you're making about the Iranians charging a fee. We'll see if that sticks or not. At this point, feels like that's probably the path forward here. That's the one way the president can stand out, declare victory, move on. Even though it's, you know, a victory only in name. You know, all we need is for the president to use that as a way to extricate himself and the military from all this, but you're still left with a fee that's not inconsequential. And then, of course, insurance companies are going to demand a higher insurance premium for insuring the traffic that moves through the strait because, you know, who knows what will happen in the future.

And then traders are going to demand a risk premium. They're not going to hold oil prices without a premium, thinking that, you know, again, the Iranian regime is still in place and can still create havoc and more than likely at some point will. Therefore, you know, you got to pay me a higher fee. So, if you told me after everything kind of normalizes, winds down, hopefully that's by the end of the year, that oil prices are at 80 bucks a barrel, you know, that sounds about right to me. So we were at 60, you know, we got as high as 110, you know, before the ostensible ceasefire. With the ceasefire, the oil is now trading at 95. And if you told me at the end of the year it's 80, I say that sounds about right. Now, you know, for the US economy, that's obviously not good. You know, we're paying more for oil and other products that are coming from the Middle East, the agriculture, chips, aluminum, you know, lots of different commodities. And so it adds to inflation, it weakens growth, it adds to the ill effects of the tariffs, which do the same thing. They raise inflation, weaken growth. But, you know, the economy can navigate through without an economic downturn. It's much diminished by what's happened and what's going on, but it's not pushed under by what's going on. Now, I'm just obviously, Ed, focused on the very near term, you know, next month, next six months, next year. There's other longer-term consequences of all this, and you, you know, you mentioned about the kind of the implicit threats around using nuclear weapons. You know, those things have consequence, I think, in the long run. They're not clip events per se, but they're corrosives on economic growth. It just creates general angst, uncertainty, and that's just not good for business in the long run.

Yeah, I view this as a part of a broader, very corrosive trend, and that's the deglobalization of the economy, that the US is pulling away from the rest of the world very quickly. I mean, you know, tariffs, immigration policy, you know, what we're doing geopolitically, and then, of course, now the rest of the world is pulling away from us, you know, very, very quickly. And when you raise the specter of military action and even implicitly make reference to potential use of nuclear weapons or other weapons of mass destruction, it just makes everyone nervous about your ability to lead and the stability of your leadership and, you know, what you have in mind. And I think it means that the rest of the world is going to be looking for different partners to do business with. And, you know, the US is a big economy, it's the largest on the planet, so, you know, it's still going to play a very central role, but increasingly less of one as we move forward. And if that's the case, if we are deglobalizing and this is just one more thing that will cause that process to continue and potentially even accelerate, that has all kinds of corrosive effects. You know, the nation has benefited enormously from the globalization process and the fact that the US is central and the US dollar is central to everything that goes on in the world. And that is now going to be under pressure. It was under pressure before all this, it will be under even more pressure going forward. And, you know, again, it's not one of those things that manifests in a particular event. It could, but that's unlikely. It's one of those things that just plays a role longer run in markets. So, you know, for example, we're going to have to pay higher interest rates. And you can kind of see it in the current context, right? I mean, historically, you might have thought if we had this kind of event and a risk-off environment and people are nervous and scared, the capital will come flowing into the United States, interest rates would decline. But that's not what's happened. Interest rates actually have increased. You know, the 10-year Treasury yield before all this was below 4%. We got as high as 4.5%. Today we're sitting at 4.4%. You know, that's indicative of things moving in a direction that's very unusual, unexpected. And there may be lots of reasons for that, but one of the reasons may be, I think, that the safe haven status of the US is under pressure because of events. We're no longer, you know, deemed to be the rock, the place you go when things are going bad, and we're going to pay a price for that in many, many ways, but it's most manifested most immediately in the form of higher interest rates.

A good rule of thumb, you know, for US gasoline prices, the cost of a gallon of regular unleaded, is that for every $10 sustained increase in oil price, you get a 25-cent increase in a gallon of regular unleaded. So if we were at 60 bucks before this all started, we kind of peaked out, you know, on a weekly basis around 110. I'm rounding, obviously, to make the arithmetic easy. That's a 50-buck barrel increase. So that would say gas, which was at just under $3 a gallon before all this, will settle in at 4.25. That's where we were headed, to 4.25. Now with the ceasefire, we're down to 95 bucks a barrel. Let's just assume, for the sake of argument, that's where we stay for a while, for the next week or two, which is, you know, obviously very tenuous. I mean, the ceasefire, who knows how that's going to play out, but let's just say it does. That's an increase of, you know, 35 bucks a barrel. You can kind of do the arithmetic. We'll settle in at, you know, somewhere around 3.75, 3.80, 3.90, something in that order of magnitude. So, you know, well above three where we were, but not 4.25. That's kind of sort of where we'll settle in. Obviously, it's not just gasoline, it's diesel, right? That's the other thing. Diesel prices have gone up even more, and jet fuel. But diesel prices have gone up quite a bit more. And that is critical to things like groceries, you know, because a big part of the cost of getting food on the store shelf is trucking it from the farm or the port. And so we're going to be paying more for groceries. And obviously, Americans are already very upset about the high grocery prices they're paying for lots of other reasons. It affects everything that's delivered at your door. You know, Amazon, UPS, FedEx, the US Postal Service now has a surcharge. So you're going to be paying more for that. And then every airline now is trying to figure out ways to raise prices for tickets and other ancillary services to compensate for their higher jet fuel costs. So the effects of the run-up in oil prices is going to be felt for, you know, quite some time. The other thing, just as a point of interest, economists have this old adage: prices go up like a rocket, they come down like a feather, right? Because especially in the current context, I've been very surprised by how quickly the pass-through has occurred, particularly with gas prices, you know, very rapid, you know, almost like as soon as oil went up a dollar a barrel, it showed up at our local gas station. But they'll come down more slowly. They'll come down because of competition, but the competition will take a while to kick in. So they'll take longer to come down. So I think we should, you know, you mentioned, I think it was JPMorgan, BofA, 4% inflation in the current quarter annualized. That sounds about right. That's what we're going to get despite the ceasefire and despite the pullback in oil prices that we've seen over the last day or so.

I mean, I think the Fed for the foreseeable future, at least the next few, couple, maybe three meetings, is on hold. They're just going to sit on their hands for two reasons. One, they don't know how this is all going to play out. You know, what exactly is the ceasefire? Is it going to hold? You know, what does it mean? Where are oil prices going? You know, I'm giving you my forecast, but I say it with no confidence, you know. So reason number one for doing nothing, sitting on their hands, is the uncertainty. The other is the nature of the shock. Just like tariffs, it weakens growth. It hurts the job market. And since Liberation Day a year ago, we've created no jobs. You know, some months up, some months down, but net net, we've gone nowhere. And now you're throwing this into the mix. All else equal, that would say to the Fed, you should be cutting interest rates, right? Because your mandate is full employment. But conversely, you have higher inflation, and your other mandate is low and stable inflation. So all equal, that argues for higher interest rates. So the net of all that is, I don't know. I'm just going to sit on my hands. I think the deciding factor for the Fed ultimately will be inflation expectations. You know, if in fact investors, business people, consumers begin to believe that we're in a world of higher inflation, and that shows up in wage demands and, you know, pass-through and the willingness of businesses to, you know, pass through their higher costs quickly to consumers, that's when the Fed's going to say, oh, I got a problem here. I can't allow that to happen. And they'll sacrifice the economy at the altar of low and stable inflation because they realize that if they don't, that inflation will only accelerate. Ultimately, they're going to have to push the economy into recession anyway, and that will be even more severe down the road. So take your lumps, you know, right now. Get inflation expectations back in. And that's kind of sort of what motivated the rate increases back when Russia invaded Ukraine and inflation took off. Inflation expectations actually did pick up. If you go back and look, lots of ways of measuring that. But you can look at, you know, five-year forwards or five-year break-evens or inflation swaps. They all showed inflation expectations were coming unmoored. And that's why the Fed jacked up interest rates in an unprecedented way. You know, they raised them more quickly than any time in history. So if inflation expectations in the current period come unmoored, then that's what they're going to do. Now, good news, at least so far, it feels like inflation expectations are still anchored. That, you know, if you look at five-year forwards or five-year TIPS break-evens, they don't look like they've pushed up to a significant degree, at least not yet. So that would argue that, you know, once things settle and the uncertainty fades and they got a better grip on, you know, what's going on with the events in the Middle East, they'll be more focused on the job picture, the weak growth, than they will be on inflation. And I think, and again, I say this with low, low level confidence, but I think the next move will probably be a cut, but not, you know, not anytime soon. At best, late this year. There's a December meeting, maybe, but more likely early in 2027 for them to start cutting rates. Now, you asked about asset markets. The other aspect of that, I mean, I think asset markets have kind of sort of bought into that. I mean, you know, depends on the day or the minute you look at Fed futures because, you know, investors are all like, you can tell I'm all over the map in how I'm thinking about this. They're all over the map, but my guess is if we look today, they'll be saying no rate cuts. Their forecast will be very similar to what I just laid out, you know, something like that. So I suspect that if that's, you know, what we get, then, you know, they should have no, at this point, no more further bearing on asset markets, stock prices, because that's embedded into their expectations, or at least ostensibly embedded into their expectations.

Yeah.

When we started the conversation, I said things kind of stuck to reasonably stuck to script. So that would suggest that we'll come close to recession. We'll feel uncomfortable. Things are going to feel very uncomfortable, particularly in the labor market, the job market. I wouldn't be surprised if we see more consistent job loss here in the next few months, but we still will be able to kind of navigate through without an economic downturn. I mean, the one thing that's kind of saving the day is the deficit-financed fiscal stimulus, right? We had the One Big Beautiful Bill Act passed last year that has tax cuts for businesses and for individuals, and the individuals are benefiting from it right now because tax refunds are larger by a consequential amount. I think the average refund check is about $350 more than it was last year. And for lower-middle-income households, that, you know, that goes a considerable way to cushioning the blow from paying more for gasoline and for groceries. And so if we had not, if that, and that's all deficit-financed, right? So, you know, taxpayers are paying for it. But if it hadn't been for that, then I think the odds of a recession would have been well over even. But with that, it's providing enough support at the same time that people are having to put all their hard-earned money into their gas tank that we should be able to navigate through. But it's going to be close. It's going to be very, very close. And that's what my modeling is saying. You know, different indicators of recession, we've talked about, I think, in the past, and they're all basically saying the same thing. The probabilities at this point are 40, 45, 50%, you know, very, very close of a recession at some point in the next 12 months. So it's, I think we'll navigate through. My kind of baseline worldview, you know, in the middle of the distribution of possible outcomes is we navigate through at this point, particularly because, you know, hopefully the ceasefire is signaling we're moving in the right direction here. But again, you know, we got to be humble, and I do think the risks are awfully high. The final thing I'll say is on that, and, you know, in response, is nothing else can go wrong. Nothing. Nothing. There's no margin of error here. I mean, everyone's on edge, you know, if anything else doesn't stick to the script. And goodness knows, I mean, things are not sticking to anybody's script here, you know, for the past year. If something else doesn't go exactly right, you know, I think we're over, recession odds are over even, and it's going to be very difficult to avoid a downturn.