Today's number: 10. That is the percentage of US-imposed regime changes that have ever led to a successful and lasting democracy. The other 90% have actually made things worse, resulting in harsher governance and, in many cases, civil war. But I'm sure that this time will be different.
Welcome to Frosty Markets. I'm Edson. It is March 4th. Let's check in on yesterday's market vitals. The major indices all dropped in early trading as much as 2.5% before paring losses. Still, they ended the day firmly in the red. Meanwhile, Treasury yields spiked again and the price of oil rose as much as 9% before pulling back on those gains. Okay, what's happening?
As war with Iran escalates, so do investors' anxieties. The major indices sold off yesterday morning as the US warned that its strikes on Iran will continue to ramp up in force. Brent crude, the international benchmark, briefly hit $85 a barrel for the first time since 2024. Then President Trump said the US will escort and provide insurance for oil tankers moving through the Strait of Hormuz. The indices recovered some of their losses on that news and crude retreated from its highs. Still, oil prices are up 13% over the past week. In the bond markets, the 10-year Treasury yield moved higher on fears that higher energy prices could boost inflation in the US. Meanwhile, the risk-off trade spread overseas, with European stocks falling 3% and Asian markets slipping. South Korea's Kospi plunged over 7%. Investors rushed to safe-haven currencies. The dollar rose to its highest level since January, and the Swiss franc hit a 10-year high against the euro.
Tons of stuff in here, tons to unpack. And so we're going to do something different today. Instead of going to one guest, we are going to go to three guests. We've got our panel of experts here. Today, we're speaking with Mark Zandi, chief economist at Moody's Analytics, who you know, Robert Armstrong, US financial commentator for the Financial Times, and Matthew Martin, Semaphore's Saudi Arabia bureau chief. Mark, Rob, Matthew, thank you very much for joining me on the show. Rob, I'm going to start with you. We've seen some interesting reactions here from the markets specifically. It seemed that people weren't that worried on Monday, and then on Tuesday maybe more worried because suddenly stocks sold off. What do you make of how the markets have reacted so far?
It seemed pretty clear on Monday morning that the market was pricing in a short, tidy little war, something on the style of Venezuela, a regime-change light where you strike or kidnap or whatever, and it all ends fairly briskly. I think the market is still pricing in some of that, but as Iranian resistance has proved a bit more resilient than expected, that has to show up in things like crude prices and, by extension, inflation expectations. That in turn means that stock prices are creeping down. Again, nothing like the worst-case scenario is being priced in right now, Ed, but a slightly worse best-case scenario is what I would say is priced in.
Now, Matthew, you're the only one of us who's actually in or around the region right now. What are you seeing in the Gulf? And does Rob's view of what investors are pricing in make sense to you?
Yeah, look, I think it does. I mean, I've been — look, I'm based in Riyadh today. I've been out and about in the city. You know, generally people are still going about business. You know, went out to dinner with some people this evening. You know, obviously the war is a topic of conversation, but it's not like it's not the only topic of conversation. People are still continuing to talk about other things, and I think that is kind of reflective in what you're seeing in markets, and that, you know, it is a factor, but it's not the number one thing that people are thinking about. And also, you know, within the region, I think people are taking this very, very differently as well. I mean, if you look in Dubai, you know, there are some people who have been in buildings which have been struck by Iranian drones who never expected that they would live through something like that and are panicking about it and are wanting to leave. And depending on, you know, you could live in other parts of the city and have no idea of what's going on and be pretty isolated from it as well. So, you know, I think that sort of goes into this kind of psychology of how people are responding to it. You know, some people are thinking this is going to be really significant, this is going to be dramatic and long-lasting, and some people are kind of taking a much more sanguine view of it.
Mark, it sounds like people are worried about this, but not maybe as worried as we would have thought a week ago, a month ago, if you told us what the headline actually is. What do you make of investor reactions?
I mean, I think the description that Rob gave is dead on. I mean, I think people are still — investors are still expecting this thing to blow over pretty quickly. Maybe it's not going to be in a day or two like Venezuela, but more like a week or two. So, if that's the case, then $10 on a barrel of oil, you know, a couple, three percentage points off stock prices, bond yields up a little bit, you know, that kind of consistent with that perspective. And I think that's kind of my sense of things. I mean, that would be my kind of baseline view down the middle of the distribution of possible outcomes. Now, the distribution is wide. Hey, there's a lot of ways this can go. And if this does drag on beyond a week or two into, you know, a month or two, then we're talking about, you know, a different kind of scenario. And I think the market reaction would be much more severe. But right now, I think, you know, people are a little disappointed maybe this was going to be Venezuela, but — and it didn't turn out to be that way, but I still think people are holding on to a week or two. So, in that context, this kind of market action is pretty close to what you would expect.
One thing, Ed, if I may, just to follow up on that, is what I would have your listeners be alert to if things do get worse, is the relationship between stocks and bonds, which is really interesting here. If you get positive correlation between the two, that's bad, right? One of the things we like to happen in our portfolios is that when the stocks go down, the bonds go up and vice versa. But an oil price shock like you might get if the Strait of Hormuz is stuck closed for a while is inflationary. So the bonds can't go up when your stocks go down, right? And so it's been interesting that they've been going down together. And that's a painful scenario. That's stagflationary. And that is kind of the pain point to watch. I think I don't have any predictions. I don't know anything about wars. I don't have any predictions for what's going to happen. But that's the thing that kind of worries you about this particular flavor of conflict.
Yeah, Mark, there are pretty significant implications, it seems, for consumers here, and that is we put oil in our cars and most of the oil is coming out of this region. What actually is the relationship between what is happening in Iran right now and how that would impact our lives and prices at home?
Well, I'll give you some rules of thumb. So, if oil prices are up — stay up 10 bucks a barrel. So, on WTI, West Texas Intermediate, which is the key price in the US, was 65 bucks a barrel before all this. Now, we're 75 bucks a barrel. I'm rounding obviously, but say it's 10 bucks. If it's sustained for two, three, four weeks, it will sustain an increase in the cost of regular unleaded by about 25 cents. So right now the US consumer nationwide is paying about three bucks for a gallon of regular unleaded. That's manageable, but a bit uncomfortable, particularly in the context of all the affordability concerns that Americans are facing right now. Everything else is up in price. The only thing that wasn't was the cost of a gallon of regular unleaded, and now it's also headed up. And of course, if it's going from 3 to 3.25, the next question is, well, is it going to go to 3.50, 3.75? And then that's real money. So, you know, it's moving in the wrong direction, it's going to make already very anxious Americans even more anxious. And in this case, the other pernicious aspect of it is, you know, a higher gas price doesn't matter at all for a high-income, high-net-worth household. They don't really — you know, it doesn't matter if they're paying a quarter more for a gallon of regular unleaded, but it means a lot for lower- and middle-income Americans. I mean, that's real money. And if you add it up over a year, it's two, three hundred bucks in addition, you know, 20 bucks a month. And that's pretty tough for people that are in that kind of situation. So, there's a lot of aspects of this, and from the prism of the American consumer, that make it, you know, more uncomfortable than it typically would be, just because of where we are on this affordability issue.
Just Matthew, when I look at the international markets, Korea's market down, Germany's DAX is also down, the FTSE in the UK on track for its worst day in almost a year. What is kind of interesting here is that it seems that the concerns are more exacerbated outside of the US, perhaps because of proximity to the region, perhaps because of what that will do to energy. I mean, why is that? How do we account for the difference here?
Well, I think probably a big part of that is going to be the impact of gas prices in particular, because, you know, we've seen the attacks on the Qatari energy facilities and the shutdowns that they've had. I mean, that's led to huge increases in the gas price, which is obviously — that's a big part of the feedstock that's going into Europe and that's going into Asia as well. And Qatar has become a huge producer of gas. So that's going to feed immediately into a big inflation problem for a lot of those economies. So I think that's really what is at the root of the way that those markets are digesting this.
Yeah. The difference between Henry Hub gas here in the United States and European natural gas is striking. You know, our natural gas is up 6, 7% or something like that. Mark may know better than me. European gas is up like 40%, and especially Germany is an extremely gas-sensitive economy. You know, the other thing, Ed, is that the US produces a lot of oil, right? I mean, at the end of the day, the US produces as much oil as it consumes. So consumers get nailed, but, you know, producers benefit — not immediately, but over time if prices remain high and persist. But in many of those other countries, they're full-on consumers. They don't produce any energy. So there's nothing but negative here. So you have these differentials across the globe because of this — the fact that the US is now the largest oil producer on the planet.
Which brings up questions of how insulated from all of this actually are we. And perhaps we are quite insulated, but it's kind of an interesting dynamic because it was us who launched the attack in the first place. So, does that essentially mean that we can kind of do what we want over there in Iran and we aren't particularly affected? I mean, let's look at, like, liquefied natural gas, for example. What kinds of effects, Mark, would an increase in LNG prices over in Europe — would that have much of an effect on the US? Would that be a problem? Is that part of the calculus for people in the administration right now?
Well, I think that's second order, third order. I mean, don't get me wrong. I mean, I think the effects most immediately and most significantly are negative for the US. There's no doubt about it. Consumers, American consumers, low- and middle-income households, the folks that vote, they're going to feel this right away and it's going to affect them, you know, in a significant way. Over time, the higher oil prices might lift investment in production in the oil patch and offset some of the negatives, but this is still, you know, soundly negative. The fact that natural gas prices are rising in Europe, you know, has effects on Europe obviously, and then that reverberates around the world in the form of weaker economic growth. But I view that to be more second, third order as opposed to, you know, the initial things that we should be worried about.
I don't think we have enough export infrastructure to really make hay off Europe's price problems. We'd like to have more export terminals and so forth. We just don't have them. I mean, I think the point of connection to US markets for US investors and how we feel it, it's going to be the Federal Reserve. So, last week we got two unpleasant inflation prints in the form of producer prices — prices paid was high — and then we had the ISM manufacturing report and their prices-paid reading was bad. And so already you can sort of see the Federal Open Market Committee thinking, geez, maybe these cutting rates might now not be so smart. And then you get another inflationary element into the picture, which is gas prices going up, which feed into food prices and have a big effect on sentiment, you know, inflation expectations. Maybe those rate cuts come off the table. And, you know, it's a horrible thing when there is something as serious and mortal and morally important as a war going on and you're sitting here talking about what a bunch of nerds in Washington are going to do with interest rates. But, you know, this is what they pay me to do. I'm not saying this is the most — I would never say this is the most important thing about what is going on right now. But the fact is where US investors are going to feel it might be through rate policy.
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We're back with Frosty Markets.
You know, the other thing, Ed, you might think — the way to think about it is, you know, the US economy has been hit by three negative supply shocks in the last year. First being the tariffs, right? That's inflationary and weakens growth. Then it's the immigration policy — heavy-handed immigration policy that raises costs and reduces growth. So now you've got these higher oil prices. So the US economy has been pretty resilient, you know, kind of managing through those other shocks. But you got to ask yourself the question, you know, at what point does this all kind of feed on itself and become, you know, too difficult to digest?
That's exactly my question. And I think the thing that is striking is what — when I look at having spoken with people who, you know, work in energy or who consult in energy, and having spoken with investors, there seems to be this assumption that this is not that big of a deal. And maybe that's right, but it seems in this discussion that there are so many larger implications here that could be actually quite rattling. There's also the question of, like, is the situation in Iran even resolved? And it seems to me there is almost no clarity on that question, in which case it seems that there is actually pretty enormous tail risk here to the downside that is not quite being reflected in markets right now. I mean, you look at the price of oil, which has gone up, but it hasn't gone up that much. People were saying it was probably going to hit $100 a barrel. That isn't really happening. Which tells me that investors say, you know, this is contained. This is only going to happen in a small region. It's not going to affect us much, and it's not going to affect other nations that much. I'll take their word for it, but I'm just a little bit skeptical of it. Perhaps, Matthew, you could provide some clarity on this question for me. I mean, I get the sense that maybe we're underrating the gravity and how much this could affect all of us.
