By Michael Every of Rabobank

As I mused yesterday, the Iranian foreign minister was bluffing when he implied Iran was not going to act in response to Israel’s attacks on its regional proxies. Overnight, around 200 ballistic missiles were again fired into Israel from Iran, most shot down in flight with the help of the US, UK, and Jordan, others hitting open areas near real targets, with only one casualty, a Palestinian. However, thinking this is a repeat of April’s “choreographed” Iranian strike that will be met by a token Israeli response is taking a bold bet.

Back in April, I said we’d revisit that episode with worse consequences; and here we are. For those who hadn’t noticed – that includes Haniyeh and Nasrallah – Israel’s strategic dynamic has changed. It’s no longer trading blow for blow with others within prescribed geography and scale but climbing the escalation ladder to force its enemies to jump off or be smashed. Iran therefore just made a huge strategic error. Indeed, PM Netanyahu, who restored Israeli deterrence while declaring there are no red lines for it in the region cannot now show Iran is off limits. Doubly, when central Israel spent the night before Jewish new year in bomb shelters. Triply, when Iran’s shield of Hamas and Hezbollah are dismantled. Quadruply, when his new coalition member is an Iran hawk and his most potent potential political rival, former PM Bennet, tweets now is the time to strike the head of the Iranian octopus. Quintuply, when western leaders are behind Israel.

Dutch PM Wilders insulted Supreme Leader Khamenei in Hebrew. Even the US stated it will help with “severe consequences” for what Iran just did rather than telling Israel to “take the win,” as reports are the US also backed Israel’s move against Hezbollah. In the second Harris/Walz-Trump/Vance debate, the first question was on the Middle East. Walz said, “Let’s keep in mind where this started,” i.e., October 7, and Israel’s ability to defend itself is “absolutely fundamental.” Vance concurred, “We should support our allies wherever they are when they’re fighting the bad guys.” Walz noted Iran is closer to being a nuclear power, a line Vance could also have used.

The list of Israeli targets proportionate to their escalation vs. Hamas, Hezbollah, and the Houthis is short:

Military radar systems would leave Iran open for IDF air attacks.

Iran’s nuclear program would require US assistance.

The simplest target is oil infrastructure to remove the earnings paying for its and its proxies’ weapons, and to destabilise the regime.

Yet Iranian state Telegram chatgroups, and an Iranian professor of literature(!) interviewed by the BBC, say if their oil is hit, they will burn Saudi, Kuwaiti, UAE, Bahraini, and Azerbaijani oil – an escalation threat we have been flagging as a fat tail risk since immediately after October 7. (Note Qatar, a key supplier of LNG to the EU, is absent from this list despite ostensibly being a major US ally…) As such, the US might also oppose this move: but that doesn’t mean it won’t happen. Of course, Israel hitting Iran too hard could mean war, dragging others in; even so, it likely sees more risk in doing too little with its next strike than doing too much.

For markets, the risk is therefore also around where one’s strikes are placed. Oil went up around 5% yesterday and has only come down slightly since; indeed, the above may still be just a tail risk – a literature professor is after all an expert in fiction – but it’s as fat as they come.

In the Far East, trouble brews too. Japanese PM Ishiba, whom I noted yesterday is a foreign policy hawk who favours an Asian NATO with regional nuclear weapons, is making headlines today for [checks notes] supporting the creation of an ‘Asia NATO’ to deter China, Russia and North Korea with nuclear weapons – American or otherwise(!) This has huge implications.    

The ILA East Coast port strike began, with worrying implications for global supply chains already strained by the Houthis, who hit two ships yesterday. Some consequences being floated by one expert include: shipping firms declaring force majeure and dumping containers around the world; congestion hitting major terminals; ships docked in the US being stuck there; and delays returning empty containers to Asia, so shortages soaring. Ship queues are reportedly already building off the east coast and could soon exceed their Covid peak. In short, this is not “$5bn a day” in a $29 trillion US economy as some bean-counters put it. The knock-on effects are far larger, exponential, and unpredictable. Presumably, the ILA will get a huge pay rise but given this is the most labour friendly US presidency for a long time, and former President Trump just tweeted support of their claims, the union may not be in a hurry to return to work.

But back to the vice-presidential debate. For markets, only three other points were worth noting:

First, Vance said Trump’s economic plan is “not just a plan, but it’s also a record,” and that said plan is attacked by people who have PhDs but don’t have “common sense.” Walz responded, “Economists, can’t be trusted. Science can’t be trusted. National security folks can’t be trusted. Look, if you’re going to be president, you don’t have all the answers. Donald Trump believes he does. My pro tip of the day is this: if you need heart surgery, listen to the people at the Mayo Clinic in Rochester, Minnesota, not Donald Trump. And the same thing goes with this.” True. Then again, like it or not, part of the debate around this election is that neoclassical economics is wrong; and that science aims to prove things wrong; and that an awful lot of national security people have been very wrong given where we are now.
Second, on housing, Walz seemed to imply houses are for living in not speculation (perhaps he picked that up on a China visit?); stressed the importance of getting access to mortgages; that giving $25,000 to new home buyers won’t push up the price of new homes by $25,000; and neither does high immigration. Vance, whom the moderator said is proposing building new homes on federal land, couldn’t say where, instead emphasizing the importance of lowering illegal immigration, energy prices, and regulation as the quick solution to cheaper housing.
Third, Vance underlined the heart of the Trump plan is high tariffs and low taxes for US production, with tariff revenue paying for social spending such as child tax credits. Walz argued tariffs are not a way to raise revenue, and it’s better to get the rich pay “their fair share,” with no details of how. Even neoclassical economists understand that the federal deficit is likely to get larger, not smaller, on that basis.

In terms of the election needle, I suspect it didn’t move much, even as Vance seems to win in some polls. However, it highlighted how much the Republican party has shifted, and that both vice-presidential candidates think, talk, and debate with vastly greater clarity than those at the top of their tickets. This was an actual debate; polite; and even had areas where the two men agreed.     

All of the above sits alongside yesterday’s notably weak employment and prices paid components in the US ISM manufacturing survey even as job openings beat to the upside: that was enough to get people just told “2 * 25” by Powell to talk about “50 – 50” again. Then again, so does everything.

Meanwhile, hedge funds are begging to get into a China bull market and Bloomberg says Chinese property buyers are queueing up to think about home purchases again. Color me cynical, but *if* this is the case, global commodity inflation is going to go a lot higher; and so, OECD interest rates are not going to be able to go a lot lower.

At which point, it won’t just be the ILA on strike, or Eastern German and Austrian centrist politicians who are out of office…