by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with an update on the war in Iran. We next review several other international and US developments that could affect the financial markets today, including a new immigration crisis in Europe and an unexpected early test of the Federal Reserve’s independence arising from Japan’s effort to put a floor under the yen.

United States-Israel-Iran: The Iranian Foreign Ministry yesterday denied President Trump’s claim over the weekend that the US and Iran have launched a new set of negotiations to reopen shipping through the Strait of Hormuz. The Iranians said they were only in talks with Oman on how to share control of the waterway. The Iranian statement prompted Trump to later issue an angry complaint that Iran’s leaders are “unbelievably duplicitous” for requesting talks and then denying them. Meanwhile, another cargo ship was attacked while transiting the strait today.

• As we discussed in our Comment yesterday, the Iranians appear to have the advantage in the conflict, as they have proven capable of absorbing intense US barrages without losing key offensive capabilities and can shut down shipping with only minimal attacks on civilian vessels. The attack today is a reminder of that. The Iranians remain in a strong position to keep imposing costs on the US in hopes of weakening it, forcing it to withdraw, and leaving Tehran with a free hand to control the strait into the future.
• We suspect Trump is correct when he asserts that the US and Iran are talking. Therefore, the Iranian denials are probably just a power play aimed at embarrassing Trump and getting under his skin. So long as Iranian leaders think they’re making Trump look impotent, they’re likely to continue playing the game.
• For these reasons, we suspect the Iranians have every incentive to keep behaving the way they have been. For its part, if the US administration can’t find a way to impose more painful costs on the Iranians, it could well continue its on-again, off-again attacks. As we have argued before, the conflict is likely to continue for at least the near term, despite investors’ hopeful exuberance every time the US signals a stand-down.

Russia-Ukraine War: Ukraine today has again launched a large-scale drone attack on the warehouses and distribution centers of Wildberries, Russia’s version of Amazon. Ukraine has claimed that Russia uses the facilities to ship military and dual-use items along with civilian goods. Even if that is true, however, the attacks are likely also aimed at bringing the war home to Russian civilians in order to generate domestic opposition to President Putin. One danger of the attacks is that they could set a precedent for bombing civilian warehouses in other wars.

European Union: After months of unusually hot, dry weather, reports indicate low river levels are starting to disrupt production in a range of industries, from river cruises to bulk shipping. The situation has become especially acute on the Danube, where water levels have receded enough to expose old World War II-era bombs and even prehistoric mammoth bones. Importantly, low river flow has also begun to force the shutdown of some nuclear generating reactors, adding another wrinkle to Europe’s energy shortage and further threatening economic growth.

European Union-Spain: After the short-lived immigrant invasion into the Spanish exclave of Ceuta on the North African coast last week, many European leaders have heavily criticized Spanish Prime Minister Pedro Sánchez for incentivizing migrants with overly lax asylum policies. In response, Sánchez has pushed back in an angry letter to European Commission President von der Leyen. The back-and-forth illustrates how the crisis could worsen political polarization in Europe and give further impetus to populist, anti-immigrant right-wing parties.

India: The government of Prime Minister Modi has proposed extending certain tax exemptions for foreign technology companies, such as Apple, when they supply machinery or tooling to an Indian factory making electronics on their behalf. The proposed legislation would extend the existing tax exemption by 10 years to 2041. The move is part of Modi’s effort to strengthen India’s tech supply chain and position it as a manufacturing rival to China.

US Politics: Three consecutive opinion polls now show Democrat James Talarico with slightly more support than Texas Attorney General Ken Paxton in the state’s crucial Senate race. Given how high-profile Texas is and how deeply conservative its politics have become, the polls will likely heighten Republican worries about the outcome of the November mid-term elections. However, our analysis shows that if the Democrats take control of one or both chambers of Congress, the resulting “split” government could be positive for asset prices.

US Monetary Policy: In an early test of the Fed’s independence under newly installed Chair Warsh, Treasury Secretary Bessent has publicly urged the central bank to expand a facility allowing Japan to borrow dollars against its US government bond holdings. In turn, the Japanese government said it would use the facility to raise dollars for its yen purchases aimed at boosting the value of the currency. If the Fed raises Japan’s borrowing limit beyond what investors feel is prudent, the move would increase concern about the dollar and further buoy US bond yields.

US Trade Policy: A group of 20 Democratic state governors has filed a lawsuit against the administration’s latest import tariffs, which were imposed against dozens of countries earlier in the summer on the basis of probes indicating the countries were facilitating trade in products made with forced labor. The lawsuit alleges the investigations were a sham merely aimed at allowing the administration to re-impose the tariffs invalidated by earlier court cases.

• The new suit could force many US firms to deal with further uncertainty regarding US tariff policy.
• If the new tariffs raise significant funds but are then also invalidated, it would create the need for another program of tariff refunds like the one underway now.

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