“Good Things Could Happen”

By Molly Schwartz, cross-asset strategist at Rabobank

President Trump spoke with reporters yesterday aboard Air Force One, saying that the US is “meeting with Iran” and that “good things could happen”—with the “could” doing some heavy lifting. What the “good things” are, or when they “could happen,” is still TBD. The other alternative is that “if they don’t work out, [the US] will go back to very strong military action.” That, of course, is dependent on whether or not these talks are actually happening (or at least happening with the people who matter) which Iran currently denies.

We heard announcements over the weekend that Trump was “pausing” strikes on Iran. But that doesn’t mean that Iran has paused strikes against its neighbors. Indeed, Jordanian and Israeli military forces both claimed to have intercepted drones in Jordanian airspace early yesterday morning, while sources from Saudi Arabia said that they intercepted drones launched by Iran-backed militias operating in Iraqi territory.

Markets, however, were seemingly unmoved. Brent crude oil futures traded sideways around $90/bbl after gapping lower on the open, while US rates were similarly sluggish. However, the US yield curve continues to flatten, now at 22bp down from recent heights of 73bp, seemingly poised to flatten further as short-term inflation and Fed hike expectations rise. Re-escalated tensions last week led to a sharp spike in 2-year breakeven yields, up more than 21bp from July 23, back to 2.16%. Meanwhile, the US OIS curve signals investor expectations of a hike by the September FOMC meeting, and more than two full Fed hikes by March of next year.

Trump is not taking a note from Warsh with regard to his philosophy on limiting communication on monetary policy, also making his stance on interest rates and the Fed very clear yesterday. Predictably, Trump re-emphasized that he thinks “rates should be lowered,” but qualified that “you need a consensus from people,” highlighting that “Warsh is great, but he has a board.” The tone came across as softer than that he used when speaking of Warsh’s predecessor (perhaps giving Warsh some wiggle room to hold rates (or hike?)), but the bar for softer rhetoric in this instance is on the floor.

In his recently published FOMC preview, Financial Times, one EU official said that “this approach does not work any more” while another lamented that they “don’t want to hear anyone talk about ‘solidarity’ any more.” Still, as Trump put it, “good things could happen.”

Perhaps that means Greece eventually signs off on the sanctions package; perhaps it means a more durable de-escalation further down the line.

For now, though, markets are left trading the gap between what could happen and what has actually happened.