Flash Market Report*: Israel, Iran, Interest Rates, and…

Flash Market Report*: Israel, Iran, Interest Rates, and…

by Brian Broberg | April 9, 2024 | Estimated read time: 8 minutes

The beginning of the second quarter 2024 started off with a bang. Monday and Tuesday (the 1^st  and 2^nd of April), the Dow Jones Industrial Average was down about 637 points. Then by Thursday, it was down another 574 points. A small recovery on Friday meant that the blue-chip Dow shed 2.3% for the week. The other indexes did better, in that, the S&P 500 lost 1%, and the Nasdaq lost 0.8%. The week’s losses are no big deal, given the all-time highs the prior Friday. But why was there so much drama during the first week of April?

Besides the normal profit taking after two full quarters of stunning market performance, the other factors center on Israel, Iran, and interest rates. But there was a fourth factor, and I’ll get to that later.

Israel’s Seventh Attack on Iran

You may know that last Monday, Israel sent two jets into Syria and bombed the Iranian consulate in Damascus, killing three Iranian Republican Guard Army generals. Of course, the media acted like this was the beginning of World War III, which it’s not. First, this is the seventh attack on senior-ranking Iranian military officers and advisors since the Hamas attack on Israel on October 7. Second, the only difference between this strike and the others is that the destruction of the consulate is considered an act of war. (Ironically, Israeli jets flying into Syrian airspace is an act of war too, but that’s a story for another day. Hint: Syria is a failed state, so official outrages were mute.)

Regrettably, Israel and Iran are effectively at war anyway, even if it is primarily through Iran’s proxies in the region. The October 7 attack on Israel by Iran’s proxy in Gaza, called “Hamas,” is as much a declaration as Israel needs to continue to defend herself. The attack on the Iranian consulate makes sense when one stops to consider that a senior representative of Hezbollah was also present with the Iranian generals. Hezbollah, too, is an Iranian proxy but is located across from Israel’s northern border in Lebanon.

That said, and even though this attack was a continuation of Israeli military actions, the strike against Iran’s consulate is an escalation of the conflict. This is why the market abruptly turned down and dropped quickly late in the afternoon last Monday.

We should all expect Iran to retaliate. More on that in a minute.

Interest Rates

What about Thursday’s big Dow decline? It would be easy to finger Neel Kashkari, president of the Federal Reserve Bank of Minneapolis and voting member of the rate setting committee. In a speech that day, he mentioned that in March he had penciled in two rate cuts for this year. He openly said that he was thinking that less cuts were needed, which is different from his colleagues at the Fed (including Jay Powell, the chairman), who have penciled in three. He even said that if the inflation rate is still moving sideways, instead of down to a 2% annual rate, then he’d be in favor of no rate cuts at all.

Remember, in January, the market wanted seven cuts and fully priced those in. I thought that was crazy, but since then, the market warmed up to the fact that it could only be three. So, on Thursday, given all the geopolitical risks (wars between countries, for example), Kashkari’s comments were a bridge too far. The market sold off. At least that is the reasoning as reported by the financial press.

But here’s something to consider: What if the investors in the global markets already suspect less rate cuts, if any at all? They know the economy is strong, unemployment is low, and corporations are growing their profits. What if the market’s reaction was more about aftershocks from Iran’s threats of retaliation? Or … what about some other circumstance?

The Fourth Factor: Ukraine membership in NATO! Really?

On the same day as Kashkari’s comments, Anthony Blinken, US Secretary of State, made an announcement at NATO headquarters in Brussels, Belgium. He was standing next to Ukraine’s foreign minister when he announced that Ukraine will become a member of NATO. Furthermore, he mentioned a summit in Washington this summer that will commemorate the 75th anniversary of the NATO alliance. He said that the summit will be used to “build a bridge” to Ukrainian membership.

If you’re like me, an average American, you should have heard a collective pin drop across Europe and the United States. The silence was so loud because many news outlets buried this announcement deep and away from the front page. It is astounding given the implications.

Consider, for example, that two major assumptions are being made about Ukrainian membership in NATO. The first assumption is that Ukraine will still be an independent country between now and the time it takes to build a bridge to membership. (Keep in mind, Finland and Sweden took one and two years, respectively, to become members. In Sweden’s case, it was effective last month. And it all occurred while these two are not at war with Russia!) The second assumption is that if Russia has not already subsumed Ukraine, then Article 5 of the NATO treaty states that an attack on one member is an attack on all. Assuming the Russians and Ukrainians are still fighting, that means that Europe and the United States would be at war with Russia the minute Ukraine is admitted to NATO’s alliance. It is not a leap in logic to realize that this is tantamount to the start of World War III! Believe me: this is the very definition of a bridge too far.

Is it possible that this is why the market was so negative on Thursday? Perhaps. One has to admit, though, there are many crosscurrents with huge implications for world peace, let alone world stock markets. Thankfully, it is too early to really speculate, which is why the market, in all relative terms, was rather subdued for the week.

Back to Iran

So, what about Iran? Most of the possibilities for retaliation can be summed up in these three options, for which I have included what I think are the probabilities:

The first option is not impossible, but not likely either. If Iran was to strike Israel directly, they would inadvertently force the US into the war. Direct attacks on Iranian soil by US air forces would be a high probability. It seems more probable that Iran will avoid this. (Iranian leadership is crazy, but not idiotic.) That said, the Ayatollahs must do something, or they will look weak in both the Arab and Persian spheres of influence.

Hezbollah might be tapped to conduct the second option, and do something akin to Hamas’s attack on October 7. But it would be without the element of surprise. Lacking this advantage, the chances of success are lower. This means that they would just continue their cross-border rocket harassment, only more pronounced.

The disadvantages of the first two options make the third option more likely. Since last Monday, Hezbollah has not attacked more deeply than the border skirmishes that have been ongoing since October 7. This is understandable, given Tehran’s rhetoric that says a response is coming, but not yet. They are thinking and planning for the how and when. The implication by the market’s benign action last week says this third and more measured response is likely.

For world markets, this would be the least disruptive. (Not that the Iranians care about that.)

We’ll see.

*”Flash” updates attempt to address less than normal trading patterns in the markets.

^{These are the opinions of Brian Broberg and not necessarilly those of Cambridge- are for informational purposes only- and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments- there may be varying degrees of risk. Investors should be prepared to bear loss- including total loss of principal.}