I. The War
Carl von Clausewitz, the Prussian general and military theorist, famously observed that "war is a mere continuation of politics by other means." He argued that war is never an end in itself. Instead, it is a tool used by states to achieve a specific political objective. Therefore, the military strategy must always be subordinate to the political goal. If the political aim changes, the military effort must adapt accordingly.
The US seems to be adapting to the war with Iran by amassing 50,000 American soldiers in the war zone to free the Strait of Hormuz and perhaps to occupy Kharg Island. President Donald Trump seems to hope that this latest show of force will convince the Iranians to accept his 15-point peace plan. He says progress is being made toward a deal, but the Iranians deny communicating with the US at all.
II. The Yield Curve
As a result, Brent and WTI crude oil prices remained firmly just below $110 per barrel today. Yet, the US Treasury yield curve edged lower, with the 2-year Treasury note and 10-year Treasury bond yields down 8 bps and 7 bps, respectively. Pre-war market expectations shifted from one Fed rate cut over the next 12 months to a rate hike late last week to none-and-done today(chart).
III. The Fed
Fixed-income investors welcomed dovish remarks by Fed Chair Jerome Powell today. He said, "Inflation expectations do appear to be well anchored beyond the short term." According to the March Consumer Sentiment Index survey, the five-year-ahead expected inflation rate is 3.2% (chart). That's high relative to the Fed's 2.0% inflation target, and it hasn't been very well anchored since the pandemic.
Powell said, "We feel like our policy is in a good place for us to wait and see how [the Iran war] turns out." This suggests he believes current interest rates are restrictive enough to give the Fed time to assess the impact of the energy shock without rushing to hike or cut rates.
IV. Private Credit
Powell didn't mention that more cracks are showing up in the private credit market (chart). Fitch Ratings released data today showing the US Private Credit Default Rate (PCDR) has climbed to 5.8%, its highest level since the index began in 2024. Treasury Secretary Scott Bessent moved today to increase oversight of the $2 trillion private credit sector.
V. Gold
Gold has been one of the more confounding market stories since the war began. After touching a record closing high of $5,311 on March 2, it has plunged 15.4% despite mounting geopolitical risk, higher inflationary expectations, and a worsening fiscal outlook, all of which should have been tailwinds (chart).
Some analysts attributed gold's drop since the war began to rising interest rates. From 2008 to 2021, gold moved inversely with the 10-year TIPS yield. Since 2022, the two have diverged significantly, especially earlier this year, with gold surging even as real yields climbed to 2.11% (chart).
Here is a more compelling explanation for gold's swoon: When the war broke out, Turkey's central bank scrambled to support its currency by selling 58 tons worth over $8 billion in just two weeks, more than all global ETF outflows combined. We suspect that Arab nations near Iran are also scrambling to sell some of their gold holdings to purchase weapons. In addition, Trump suggested today that they should help pay for the war.
In any event, gold has been the superior inflation hedge over the long run (chart). In the short run, the war is already heating up inflation, but it is also weighing on gold for the reasons just mentioned. When the war ends, gold should resume its ascent.
