Iran war drags into month 3 as inflation bites | Morning Bid

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[00:00:02]Today, 3 months into the Iran war, oil prices and borrowing costs are heading back higher again as the United States in Iran resume military exchanges.

[00:00:10]>> Plus, a US inflation update for April dominates a busy day for economic releases.

[00:00:16]>> And just how do currency markets and the dollar read President Trump's changed tone on Fed policy?

[00:00:22]This is Reuters Morning Bid, bringing you unfiltered market news and analysis straight from the Reuters newsroom 7 days a week. I'm Mike Dolan in London.

[00:00:30]>> And I'm Anna Schmansky. It's Thursday, May 28th.

[00:00:35]>> Well, just when it seemed like maybe we were getting closer to a peace deal in the Gulf, now have resumed hostilities and it looks like we're as far away as ever and markets are responding accordingly.

[00:00:47]>> So, we're in the third month of this war. Uh it's May 28th today. It was February 28 when it all kicked off and it's worth casting back to almost a distant memory at this point, but President Trump indicating that it would be 3 to four weeks of a campaign. And so that kind of puts the context of how long this is dragging. So, you know, you can take your um uh any number of analysis of what's happened in the last few days, but it it it's not uh doing anything to free up what the finance and economics world will be most focused on, and that's the kind of uh hiatus in the Gulf and and Gulf shipping. Um those military exchanges overnight were were something of a surprise. Both sides hitting uh their respective military bases. Um there's also uh plans for another campaign uh by Israel in southern Lebanon. And we we really don't know whether this is the final throws of of something until we get uh a deal, but we've been here so many times before, it's virtually impossible for markets to to take a guess or a punt on this at this point. So, um, as you'd expect, oil prices up are back around $100 a barrel this morning, which is where they've been hovering pretty much for most of those three three months. And, uh, stock markets back a little bit. But as we talked about endlessly that they have been focused on other things but the one area that um may bring it all together which is higher borrowing costs certainly in terms of government bond yields uh are responding again and the 10-year US Treasury yield back above that 4.5% level that people kind of think is a bit of a threshold for when things start to bite. So we'll get we'll get a good picture of of really how this is coming home to Americans later today as well with with the April inflation update.

[00:02:38]>> Yeah. So there's a lot of economic data coming out today, but as you said, I think mostly much of the focus is going to be on those PCE numbers.

[00:02:46]>> Yeah. And look, there are um for April and we've already seen the CPI number which was was a bad number in anyone's book uh for April. Um they will come in if you believe consensus around 3.8% 8% higher for headline PCA inflation.

[00:03:03]That's almost twice the Fed's target. Uh and we're pretty sure given all of the um now casters as they're called uh of inflation for May coming in above 4%.

[00:03:16]So, so you can see why why the Fed is having to turn and we're seeing uh more and more of the Fed's senior policy makers now beginning to realize that the possibility uh as Christopher Waller the board member said earlier this week, you know, the idea of Fed easing into this is crazy. Uh and Lisa Cook, who we haven't heard for some time, um she said last night, another Fed board member, uh that she was prepared to raise rates if disinflation didn't resume soon. And you know, as long as this war is going on, as long as these energy prices remain high, it's very, very hard to see where that disinflation uh when that might even start. So, so that's a that that throws us into um a really difficult position for for any uh calculation on interest rates because uh there's certainly no sign of it happening this year and we have to look at where the markets are priced, which is for the next move being up. And one of the things that you've written about and that has really been quite interesting is how what the markets are pricing and what fund managers are thinking has really been differing that markets since essentially at some point in March just started taking out any expectations of cuts and as you said are now actually looking for potentially a hike whereas up until at least early May majority of fund managers were still expecting there to be cuts and I think a lot of that had to do with Kevin Worsh coming in and this expectation that he was going to be coming in as Trump's appointee and obviously President Trump has made it very clear up until recently that his desire was going to be for cuts. But his his tack on that has has really started to shift in the last week or so.

[00:04:53]>> Yeah, it's kind of fascinating, isn't it? Because we're seeing not only uh that shift in the at the Fed as Worsh comes into the top job. Um but we're also seeing clearly the opinion poll ratings uh certainly on uh economic opinion economic policy approval ratings uh for Trump plummet um even amongst uh Republicans um and particularly on the cost of living issue with gas prices rising or as high as they are. Um so you have to wonder at the White House what would be the response? it would seem a very very strange thing to go in and say immediate rate cuts into that sort of idea because it would suggest that you don't care about uh the rising inflation. So the signals Trump has been given over the last week has been that he's going to allow his new appointee to to do the job he has to do. So he give the Fed uh some room to get on with the job if you like signaling to the wider public that the Fed is in control of this inflation story. So Wart will be faced with that uh with that um task of of of ultimately saying that he agrees with the president that interest rates will fall at some point in the future due to longerterm issues. But right now the Fed is across what is a very worrying inflation picture. And I think the timing is really key here because Trump may be signaling not necessarily that he's completely changed his thoughts on interest rates, but just that, as you said, he understands that in the current moment there simply is no space for cutting. And he indicates that he believes that once there is a deal, if there is a deal at some point, that energy prices will come down, inflation will come down. Now whether any of that's going to happen is very much an open question, but it does create this kind of new space that we haven't seen in a while where Worsh may not have actually so much pressure to push for cuts. That has implications not simply for rates, but also for dollar policy, which has really been something that while this administration hasn't explicitly said that they're looking to weaken the dollar, a lot of what they've done since Trump um came in this second time, has clearly appeared to be to weaken the dollar with the goal of encouraging industrialization or re-industrialization in the United States. you it's it's important to zoom the lens out a bit and and see what the the the economic policy agenda if you like of the of the second term Trump term was really all about and and certainly on the Hustings running into the campaign what people were voting for was obviously this idea of of um uh reinvigorating US industry partly uh through his trade policies and and the tariffs that we've seen through the last year uh and also this idea that the overvalued dollar was somehow disadvantaging US uh exports and US industry at large.

[00:07:41]So this uh while not terribly explicit in terms of the statements made about the currency of the exchange rate, which is a very sensitive thing they probably wisely steer clear of, but there was a running assumption through many of the uh pre-election writings of many of Trump's advisers at least that there was a a a policy that would weaken the dollar. that was joined at the hip with uh the idea that get interest rates down. Right? So the two at least were consistent in that regard. But if you change the picture of the economy at large and a lot of people are certainly at the Fed and perhaps even in the White House, then this is a hot economy. And you know, it's not just because of the energy situation in in the Gulf as we talked about yesterday. This is very much a a a um AI tech buildout that that that's also creating its own bottlenecks and inflation pressures. So this this this doesn't look like a world where you where you floor interest rates where where where you you push interest rates down to to 1% or whatever Trump has been demanding while J Pal is in the chair.

[00:08:44]So if you change the attack on that, does he also think that the dollar is not uh necessarily a tool to use to re-industrialize it? And there are many uh Republicans even in the background certainly uh Republican supporters uh who suggest he should drop that uh and and and pivot away from that as well.

[00:09:02]Glenn Huard who was a former uh council of economic adviserss uh chair under George W. Bush, he's he wrote this week that the the president was uh would be well advised to stop any suggestion that the US was uh pushing for a weaker dollar because it just adds to that inflation picture and it also adds a problem for what is um a mounting debt problem as well which is uh combining to get uh borrowing costs as we've been saying higher and higher and yes it is notable that the uh US fixed mortgage rate. Uh the 30-year fixed mortgage rate hit its highest in 9 months. So these higher borrowing costs are filtering across the economy and it's largely because uh there is an inflation problem and increasing an interest rate problem.

[00:10:00]>> For more on what Trump's shift could mean for the Fed and the dollar, check out Mike's latest column. The link is in the show notes. And for more of any of today's stories, head to reiters.com or the Reuters app. Follow us on your favorite podcast player. And if you're on a smart speaker, just ask for the latest market news from Reuters 7 days a week.

[00:10:16]>> We'll be back tomorrow.