Last call for Tacos?

Good morning. The US stock and bond markets didn’t care much about the US strikes in Iran. The S&P 500 moved up — up! — by 1 per cent yesterday despite the rising tensions in the Middle East. The oil price, more shockingly, came down over 7 per cent (more on that below), even before the US president posted that a ceasefire was in place. Sometimes markets are a terrible gauge of geopolitical risk. In this case, we hope they are exactly right. Email us: [email protected].  

Is the Taco trade over?

Over the weekend, several people declared that the bombings by the US of Iranian nuclear facilities proved that the Taco (“Trump always chickens out”) concept is no longer true, or never was. Some of these people are not fans of my work, and said mean things about me on the internet. Other people declared that the acronym had actually played a part in Trump’s decision to drop the bombs. The latter comments ranged from joking, to half joking, to not joking at all.

Let’s dispose of the second point first. I don’t believe it. If I hadn’t coined Taco, the war would have unfolded the same way. At most, “Taco” put a useful label on a real phenomenon that everyone was noticing; the idea would have coalesced in another form without the acronym. Suggestions to the contrary horrify me. I am a middle-aged finance writer from Brooklyn. I am irrelevant to history and old enough to like it that way.

The first point is more subtle and challenging. First, a reminder of what Taco means (as Unhedged intended it). It labels, first, an undeniable pattern of behaviour: a big policy promise or threat, soon followed — before serious negotiations with a counterparty have begun — by a big watering down of the threat. Second, it labels a psychological claim about Trump himself: that, placed under a bit of pressure, he turns out not to care very much about many of his signature ideas. He wants to be perceived as strong and successful. If a policy he has trumpeted starts to look like it will dilute that perception, he folds. Trump is just not that ideologically or personally committed to any policy.

On the point about self-image, it’s fair to ask whether Trump is very different from any other politician in this respect. But the differentiator is the volume of his bluster at the outset; Taco is a reminder to discount it heavily.  

A final point is that, for Unhedged, Taco is about economic policies, especially tariffs but also, for example, immigration enforcement. Whether it applies in foreign policy or wars is a question for someone else to think about. 

Before declaring Taco dead, a couple of questions. Did Trump perceive bombing the nuclear facilities as a big risk to his popularity? Or did he think that, with Iran badly weakened and the general anti-Iran sentiment in the US, dropping a few bombs was unlikely to blow back on him, and maybe even help his standing? I have no idea. But you can’t declare Trump a bold risk-taker if these were not, in his own estimation, big risks.

Next question. Granting for the moment that Trump has proven an appetite for risk geopolitically, does that mean that Taco never applied to domestic economic policy, either? My guess, for the record, is that the president’s risk appetite (if that’s what he demonstrated over the weekend) is domain specific. On tariffs, for example, I’d bet the Taco trade keeps working.

Oil (and other commodities)

Even before Trump’s ceasefire announcement yesterday evening, the market was heavily discounting the possibility that Iran would close the Strait of Hormuz. Oil prices were restrained most of Monday, and, surprisingly, plummeted 7 per cent when Iran launched missiles towards a US military base in Qatar in the afternoon.

While that might have seemed like escalation, traders, pundits and the president seem to have read it as the opposite. Iran’s strike looked like a signal that the regime was ready to de-escalate. It was limited and telegraphed; the Iranian military lashed out at the US military, rather than the Strait or softer targets. Indeed, Iran’s leadership has not made any public moves to close the Strait. Closing it would hurt Iran’s own oil exports in an already precarious economic moment, and a jump in oil prices and inflation would anger the international community, including its few remaining allies, at a time when the regime is very weak. 

Oil prices are now trading at the same levels as before the US and Israel’s attacks.

The move down may not have been a case of market prescience, or even of market optimism, however. According to Ilia Bouchouev of Pentathlon Investments, the price decline is due in part to technical dynamics:

The world consumes 100mn barrels of oil per day, but the market trades at least 6bn barrels a day . . . Oil prices are uncorrelated to inventories, and highly correlated to the positions of money managers and hedge funds [in the oil market]. From a certain perspective, they are the ones driving the market. And sometimes there are liquidity gaps, where there are not enough fundamental participants to take the other side of [their trades] . . . Also, oil producers tend to hedge their price exposure [by buying put options to lock in higher prices, and selling call options to finance them]. When the price gets close to their strike, they sell futures. That exacerbates movements in the market.

Yesterday’s fall looks like a prime example, Bouchouev thinks. The market was not necessarily responding to fundamentals, nor telling us that a closure will never happen.

While we, and the rest of the commentariat, have been focused on the impact of a closure on oil prices, we have not been paying much attention to oil byproducts — particularly fertilisers. This was pointed out to us by Dec Mullarkey at SLC Management, an old friend of Unhedged. According to Kpler, a trade data company, 33 per cent of the world’s fertilisers pass through the Strait of Hormuz. If the hostilities re-escalate and the Strait is closed, we could see a move in global food prices above and beyond what higher energy prices typically imply for agricultural costs. Indeed, we have seen some agricultural commodity prices move with oil prices since Israel began its attacks on Iran:

But, commodity traders tell us, the agriculture commodity market is mostly looking through the war, too. According to Dan White, head of research at Blue Line Futures, and his colleague Oliver Sloup, soyabeans and other agricultural commodities have been trading in line with normal seasonal patterns. And US and other global producers often lock in their fertiliser prices ahead of the growing season, so a rise in fertiliser prices would not be immediately reflected in crop prices. Corn is a case in point. Corn prices have fallen in the same period, driven down by supply dynamics:

The notable exception is soyabean oil, which staged a huge rally last week — bigger even than crude oil. According to White, that is partially from the upward drift in oil prices and other energy markets from Iran, as soyabean oil is commonly used as a biodiesel. But it is also from other, unrelated forces, including new regulations in the US.

Unhedged loves a tidy explanation. But Iran has not explained everything in commodity markets this week. 

(Reiter)

One good read

Denisovans.