Wall Street is playing a very dangerous game with Trump

On Friday, after Iran declared the Strait of Hormuz open to commercial vessels, the oil price dived and the US sharemarket hit another record.

On Saturday, the strait was closed again after Donald Trump said the US blockade would remain in place, Iran fired on two India-flagged vessels, forcing them to turn back and then, on Sunday, the US fired on and seized an Iranian ship.

So much for Trump’s claim last Friday that Iran had agreed to never again close the strait, which he hailed on social media as “A GREAT AND BRILLIANT DAY FOR THE WORLD.” With Iran saying it will skip more ceasefire talks while the US blockade remains in place, the prospects for an end to the war remain as uncertain as ever.

Trump said on Sunday that his representatives were returning to Pakistan to resume negotiations, but didn’t help defuse the tensions with yet another of his social media postings.

“We’re offering a very fair and reasonable DEAL, and I hope they take it because, if they don’t, the United States is going to knock out every single Power Plant, and every single Bridge, in Iran. NO MORE MR. NICE GUY!,” he wrote.

Iran has said, in response to previous similar threats from Trump, that it would retaliate by blowing up its neighbours’ power plants and desalination plants. If the US were to do what Trump is threatening, the regional damage from the war, already extensive, would be far greater and more lasting.

While the hostilities, and the tone of Trump’s social media posts, escalate and de-escalate – he has regularly declared victory and an effective Iranian surrender only to follow almost instantly with dire threats when it becomes apparent that they haven’t – the US sharemarket continues to gain as if the war never happened or, if it did, is immaterial to their decisions.

While there has been turmoil in the oil market – the price has fluctuated violently in a range well above its pre-war starting point of just below $US70 a barrel – the sharemarket, after initially falling about 8 per cent after the initial assault by the US and Israel, has subsequently bounced back by more than 12 per cent to record levels.

Other markets have behaved differently. The ASX, for instance, fell 9 per cent at the onset of the war but, while it has recovered some ground, remains about 3 per cent below pre-war levels.

The US bond market has traced a similar course, with yields initially spiking, across the yield curve, by 40 to 50 basis points before falling back somewhat after ceasefire talks began. The yields on the key two and ten-year bonds, however, remain more than 30 basis points higher than before the war.

The US dollar strengthened in the aftermath of the initial strikes on Iran, appreciating about 3 per cent against a basket of its major trading partners’ currencies. It’s now fallen back and is only about 0.5 above the pre-war starting point.

The US sharemarket, therefore, appears to be the only market that seems to be trading as if the war weren’t ongoing and that what the International Energy Agency has described as “the largest energy security threat in history” wasn’t still unfolding, having already wrought sufficient damage to threaten global economic growth.

While the International Monetary Fund, the World Bank and central bankers fear permanently higher high oil and food prices because of the closure of the strait and its demonstration effect – it has shown that Iran has the ability to shut it down whenever it wants if it is prepared to deal with the consequences for its economy and infrastructure – US investors appear to discounting the war’s impacts, even ignoring them.

They appear more focused on domestic settings than the geopolitical context, although even there they are discriminating.

When even Christopher Waller, a Federal Reserve governor who was on Trump’s short list to be its next chair, is saying, as he did on Friday, that the US economy is at risk of a COVID-style inflation shock, you’d expect investors to be conscious of the threat to domestic economic growth and stability.

Waller said the war could produce a lasting increase in inflation that could result in a “very complicated” stagflationary outcome of high inflation and a weak labour market that prevented the Fed from cutting interest rates to boost the economy. That suggests the Fed may not be able to, as it has done during previous economic shocks, put a floor under stock prices.

The war and Trump’s tariffs are resulting in rising inflation rates and slowing economic growth in the US and elsewhere. Interest rates are set to rise, despite the reduced growth. The US bond market and markets outside the US appear to appreciate that.

So why are US equity investors so sanguine. It’s presumably not because they believe Trump’s bombastic and habitually misleading Truth Social posts, although it is possible that they have concluded the war will end soon and its impacts will be shorter-lived than others believe.

It may, of course, revolve around a conviction that Trump will, as usual, fold – “chicken out” – when it becomes clear Iran won’t agree to the terms he has declared non-negotiable and the political damage becomes too material to ignore.

There are still plenty of investors and analysts (and probably Iran’s leadership) who believe he will declare a victory, however hollow, and move onto something else (Cuba? Greenland? Withdrawal from NATO?) if the situation in the Middle East becomes too difficult.

They also probably believe that the “Fed put” that they have relied on for decades – the conviction, borne out of experience, that the Fed will always ride to their rescue with lower rates and torrents of cheap liquidity – remains intact. That would, of course, mean discounting the odds of a stagflationary environment.

There is some positive news to encourage US investors. First-quarter corporate profits were above expectation and evermore sophisticated and practical applications for artificial intelligence are emerging at a rate that is well beyond earlier expectations.

With Iran saying it will skip more ceasefire talks while the US blockade remains in place, the prospects for an end to the war remains as uncertain as ever.

While it’s coming as enormous cost – the biggest of the “hyperscalers,” or the tech giants like Amazon, Microsoft, Alphabet and Meta are expected to invest more than $US600 billion ($839 billion) in AI this year – and the returns so far aren’t anywhere near commensurate with the risk capital being invested, the value of the “Magnificent Seven” largest tech stocks have soared about 20 per cent since their low point this year, immediately after the war broke out.

The investors don’t appear to be concerned that the spending for computing power keeps ratcheting up quite dramatically, that there isn’t the power within the US electricity grid, or sufficient reliable sources of water, to meet the projected demands of all the data centres on the drawing boards, or that suppliers of the chips and copper and even capital are struggling to keep up with the AI sectors’ needs.

In any event, whatever the reason – it could be that an overload contradictory information of information flowing from the White House and the Middle East has made it impossible for investors to reach any conclusions, or perhaps has simply desensitised them to its risks.

The US sharemarket, unlike the bond market, isn’t pricing what to most investors would appear obvious risks.

Maybe the equity investors will be proven right. Either Iran or Trump might fold and end the war, with the strait reopened and, somehow, the threat of any future closure removed.

War damage in the Middle East and its impact on the flow of energy, fertilisers and other commodities might be remedied far quicker than expected.

The inflationary impacts might be fleeting and the effects of increased debt-funded spending by already overly-indebted governments around the world – including, especially, the US – might be more than offset by higher-than-expected economic growth rates.

All these things are possible. Maybe the US equity market is operating within a parallel universe, one largely sheltered from outside influences by the sheer growth rate of AI.

If its universe were to collide with the one the rest of the world and the more risk-conscious bond investors now inhabit, of course, the aftershocks could be quite violent.

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