Markets love taco Tuesday - Global market update

One of the disturbing developments in recent months when it comes to financial markets has been the proliferation of uncannily timed trades on so-called prediction markets. For those that don’t know, these markets allow customers to bet on binary outcomes of future events, where prices are determined by how other participants bet. Users can place wagers that appear to resemble ordinary investing but also offer unconventional markets such as whether Jesus will return to Earth or whether specific events will happen in the world. Lately, under this latter category, we have seen suspiciously well-timed bets, many of them from newly opened accounts, on developments around the conflict in Iran, the capture of Nicolás Maduro and other topics close to the truth social account of the US president.

Therefore, while many people believed/hoped that the US administration would ultimately serve up another ‘TACO’ (Trump Always Chickens Out) to hit the off-ramp from this conflict, the financial markets were clearly not expecting a ceasefire to emerge so quickly. Last Tuesday morning, Polymarket betting suggested just a 30% chance or so of a cessation of hostilities by the end of the month, let alone the end of the day – and no new accounts opened to place a large bet any time during the day!

There is no denying that a delay in attacks on Iranian civilian infrastructure and (at least) a two-week pause in military actions is a significant short-term positive for risk assets, IF it holds. The associated commitment from Iran to open the Strait of Hormuz pushed spot oil futures down nearly 20%. However, uncertainty around the details and durability is significant as both sides' statements are contingent on the other's behaviour. There are large gaps on key issues between Iran and the US. Those gaps may be even larger considering the interests of Gulf countries, Israel and interested parties in Asia and Europe. That led to doubtful headlines on both sides in addition to reported (but smaller scale) attacks across the region. It's hard to see a resolution of key issues without further military and/or economic pressure on both sides.

While it looks like equities and bonds are hitting the button for a ride up in the elevator and crude oil falls down the lift shaft, how enduring it all proves to be will depend at least partially on future developments among the belligerents, though most people probably hope the ceasefire holds as more TACOs are served up in coming weeks.

The social-media sparring over who has “won” the conflict makes for entertaining, if simultaneously depressing, reading. The notion that this sort of thing is zero-sum seems awfully simplistic, not least because there are different layers of strategic goals that have had different degrees of success. Naturally, people gravitate to the ones that are most flattering to their particular viewpoint. Moreover, there is also the issue of collateral damage, both literally (in terms of regional infrastructure) and metaphorically (the energy squeeze that has impacted most of the world).

The latter issues are the most important from a financial-market perspective. Energy markets have responded vigorously to the ceasefire announcement, though we are not going back to where we were in late February (in terms of the supply and price of crude oil and distillates) any time soon – and while the price may well be down a lot from recent highs, let’s not forget it is still substantially higher than the start of the year, which will impact inflation rates across the globe.

Following the large one-day relief bounce last Wednesday, the big question for investors is what’s next? A year ago, many were sceptical that the market could execute a V-shaped bounce from the Liberation Day sell-off, but that proved to be incorrect. So it is natural to think that the same rapid rally to a new high could happen this time around. Energy prices are a variable that didn’t really factor a year ago, so it’s not quite an apples-to-apples comparison. Other factors at work would suggest that trading liquidity has deteriorated significantly in recent weeks and that price action may be driven by players other than traditional asset managers. Given how difficult it is to model the timing and outcomes of a war, analysts have been slow to alter their earnings forecasts and so prices and earnings expectations have diverged significantly.

In a sense, you might feel like you’ve got a devil on one shoulder and an angel perched on the other. The angel on my shoulder says it all sets up for the sort of Fear Of Missing Out (FOMO) squeeze that we have seen after many of the recent dips and corrections of the past few years, and the rip higher will be just as fast as the descent. The devil on the other shoulder, meanwhile, says that if just about everyone thinks that Middle East risk is over, then the chances of a nasty surprise are now pretty high. After all, military drones are still flying in the region and hitting energy targets.

One thing that is worth remembering is that if you gorge yourself on too many tacos, too often, then the risk of indigestion is always there – you don’t have to reach for every plate that comes your way!!