Category: Middle East

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Iran: What Comes Next?

Key Points

  • Combined air strikes on Iran by the US and Israel make good media coverage but are unlikely to lead to regime change.
  • An Iranian strategy that prolongs the conflict while increasing the cost to the US and its allies has the potential to frustrate US ambitions.
  • Rising crude oil prices and increased US deficits will likely fuel a sharp increase in inflation.

President Trump succeeded in diverting media attention from his troubles at home, with attention-grabbing headlines about Operation “Epic Fury” in Iran. But does he have a clear end goal? He claims the Iranians have requested talks, but they deny it. So what happens if the Iranians are unwilling to give Trump his media victory?

Predictions of a “short war” typically underestimate the opponent and the unpredictability of war.

Many things in war are unpredictable, but some are self-evident:

  • Israel does not have the manpower to wage a full-scale war against Iran.
  • The US public does not have the stomach for a large war, and US leaders want to avoid putting “boots on the ground” at all costs.
  • US allies in the Middle East are equipped with modern air defense systems that can protect them from most missile and drone attacks, but they don’t have the stockpiles of weapons to endure a sustained barrage over several months.
  • Oil tankers carry 21 million barrels of crude oil through the Strait of Hormuz every day. Four ships have already been damaged. Closing the Straits would halt the flow of 20% of global oil production, causing a massive supply shortage and spike in oil prices.

Crude Oil Flows Through the Strait of Hormuz

Brent crude prices shot to above $80 per barrel on Monday.

Brent Crude

Robin Brooks compares the current price rise to Russia’s invasion of Ukraine in 2022:

Today’s post …. benchmarks the current shock versus Russia’s invasion of Ukraine four years ago. Russia is a massive oil producer and – at the time – markets worried it would get shut out of the global economy. Yesterday’s spike in oil prices was more than three times as big as the rise on Feb. 24, 2022, the day Russia invaded Ukraine. That’s a big shock no matter how you cut it.

Iranian officials say they have closed the Strait of Hormuz. US Central Command says that is not the case. But tanker rates and insurance costs have skyrocketed.

Lloyds List highlights the steep rise in very large crude carrier (VLCC) rates:

BALTIC Exchange indexes for very large crude carriers loading in the Middle East Gulf reached record highs on Monday. Iranian attacks on tankers and insurers’ withdrawal of war risk cover have effectively closed the Strait of Hormuz.

Spot rate strength in the MEG has cascaded through global freight prices, leading to a surge in rates for VLCCs and other tanker segments worldwide.

The Baltic Exchange’s MEG-China TD3C index went parabolic after the outbreak of war, coming in at a record $423,736 per day on Monday, up 94% from Friday.

Crude Oil Tanker Rates

Global Impact

China gets about 45% of its crude oil needs from the Middle East, with 11% from Iran.

Global Oil Trade

  • Russia, as a large oil exporter, would benefit from a spike in crude oil prices. So would Canada and African exporters like Angola.
  • Large oil importers — China, India, Japan, the rest of the Asia-Pacific region, and Europe — would all suffer from a steep rise in crude oil prices.
  • The US is a net oil importer. While less affected than other major importers, the US has experienced steep rises in inflation during past spikes in crude oil prices.

The 1973 Yom Kippur War and the Arab oil embargo caused a massive jump in crude oil prices, with CPI reaching 12.0% (red- RHS). The Iran-Iraq war in 1980 caused an even steeper spike in inflation, with CPI at nearly 15%.

WTI Crude & CPI

During the 1990 Gulf War, CPI rose above 6.0%. However, during the 2003 Iraq War, deflationary forces— from the collapse of the Dotcom bubble and China’s entry into the WTO — helped offset inflationary pressures from higher crude oil prices.

WTI Crude & CPI

Crude oil prices had already spiked in 2021, but Russia’s full-scale invasion of Ukraine in February 2022 lifted annual CPI to 9.0%.

WTI Crude & CPI

US Deficits

The US federal debt is at a precarious 122% of GDP, and budget deficits remain stubbornly high. The US does not have much spare capacity to wage an extensive or protracted war without generating high inflation.

Federal Debt to Nominal GDP (%)

Conclusion

China’s dependence on crude oil imports is its Achilles heel. The country imports 11 million barrels of crude oil per day, and much of that flows through the Strait of Hormuz.

Chinese leaders will be watching the US-Iran conflict with alarm. US control of the Strait of Hormuz would have China at its mercy. China’s blue-water navy is decades away from being able to challenge US naval supremacy in the Indian Ocean. The only effective way for them to intervene in the current conflict would be to supply Iran with advanced weapons that can challenge US naval dominance.

The Iranians have been battered by air strikes before. They know that a full-scale US invasion is unlikely, and that nothing short of that will likely remove them from power. Their best strategy is patience. They can afford to wait the Americans out. Increase the cost of the war and frustrate US efforts to achieve a decisive outcome. Another protracted conflict in the Middle East, with sky-high oil prices causing a steep rise in inflation, will soon sour US public opinion and lead to yet another retreat.

A protracted conflict in the Middle East would also increase US fiscal deficits. Inflation will likely rise, fueled by increased government spending and rising crude oil prices. Higher inflation and further increases in government debt would increase term premia on long-dated Treasuries. High long-term interest rates would raise the cost of servicing government debt and further increase the deficit.

Attempts by the Fed to suppress long-term interest rates, through QE or other means, would further fuel inflation.

Our strategy is to remain heavily overweight in gold and defensive stocks with stable income streams, and underweight long-term financial assets and high-multiple growth stocks.

Acknowledgments

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US-Iran Update

From Vali Nasr, professor at Johns Hopkins University and author of Iran’s Grand Strategy: A Political History:

The US appears poised to launch a major military attack on Iran. The last round of talks between the two countries was an opportunity for Iran to avert war but Tehran offered little to Washington. That is not because Iran’s rulers are too obdurate and caught up in their old ways of thinking. Rather they are putting little stock in diplomacy and increasingly see war as inevitable. They see talks more as a trap than a solution and seem to view an unavoidable war as more cathartic than a weak deal. They are focused on how to manage it — and even use it to their advantage.(FT.com)

From Linus Höller at Defense News:

BERLIN — Bulgaria’s Sofia International Airport briefly suspended civilian air operations twice over the weekend while a fleet of American military aircraft staged at the facility, fueling speculation that Washington is positioning forces ahead of a potential strike on Iran.

Photographs circulating on social media showed at least six KC-135 Stratotanker refueling aircraft from the 6th Air Refueling Wing at MacDill Air Force Base, Florida, along with C-17 and C-130 cargo planes and Boeing 747s typically used for troop transport, parked at the airport’s Terminal 1, according to Obektivno.BG.

Bulgaria’s Ministry of Defense confirmed the U.S. Air Force presence, describing the deployment as support for “training related to NATO’s enhanced vigilance activities,” …..

Bulgarian investigative journalists have tracked more than 120 U.S. Air Force aircraft that crossed the Atlantic within days, including four dozen F-16s, three squadrons of F-35A stealth fighters, and 12 F-22 Raptors.

Similar deployments, including F-22s staged at RAF Lakenheath, preceded last June’s Operation Midnight Hammer strikes on Iranian nuclear facilities.

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Israel strikes first

Summary

  • Israel struck nuclear facilities and military command structures in Iran
  • The government declared a state of emergency in anticipation of retaliatory attacks from Iran
  • US Secretary of State Rubio indicated that the US had been notified but was not involved in the strikes
  • Iran had earlier threatened to attack US bases in the Middle East in response to any attack

Israeli Premier & F35 Fighter Jet

Israeli Premier Benjamin Netanyahu with F35 Fighter Jet

Israel launched dozens of air strikes targeting Iran’s nuclear facilities, ballistic missile factories, senior military commanders, and nuclear scientists on Friday, warning that this would be a prolonged operation. (FT & Reuters)

The strikes come after an International Atomic Energy Agency (IAEA) resolution on Thursday declared Iran in noncompliance with its nuclear safeguards obligations for the first time in nearly 20 years….Iran’s uranium enrichment has reached 60% purity — a dramatically higher level that is a short technical step from the weapons-grade purity level of 90%. “A country enriching at 60% is a very serious thing. Only countries making bombs are reaching this level,” IAEA chief Rafael Grossi said in 2021. (CNBC)

Iran’s Defense Minister Aziz Nasirzadeh told reporters Wednesday that if nuclear talks fail and “a conflict is imposed on us,” the Islamic Revolutionary Guard Corps “will target all U.S. bases in the host countries.”

A source familiar with the situation and a U.S. official told CBS News that the Trump administration was weighing options regarding how to support Israeli military action without leading it…
The source said the options are unlikely to include direct participation by U.S. B-2 bombers that carry the type of bombs that can penetrate Iran’s deep underground fortified uranium enrichment facilities at Fordow and Natanz. Without that type of strike, it is unlikely Israeli military action could destroy the underground portions of Iran’s program, and thus solo military action by Israel is presumed to be limited in its capability to fully eliminate the program. (CBS)

Conclusion

Israel won’t back down (I-W-B-D).

Israel faces an existential threat from a nuclear-armed Iran and will strike first in an attempt to eliminate the threat. The strikes may delay Iran’s uranium-enrichment program, but are unlikely to prevent the country’s leaders from pursuing their nuclear weapons goal.

The only way to eliminate the threat would be a full-scale invasion, which is likely beyond Israel’s capability. The US will offer support but is unlikely to become directly embroiled in the conflict unless attacked by Iran.

Oil prices are expected to spike due to supply concerns, while a flight to safety will likely boost gold demand.

Acknowledgments

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Give War a Chance | Edward Luttwak

UN Peacekeepers in Bosnia

UN soldiers at a NATO base near Brcko, Bosnia, March 1998 | Juergen Schwarz, Reuters

This 1999 opinion in Foreign Affairs magazine, by Edward N. Luttwak, a senior fellow at the Center for Strategic and International Studies, is relevant to today’s conflicts in Ukraine and Gaza:

An unpleasant truth often overlooked is that although war is a great evil, it does have a great virtue: it can resolve political conflicts and lead to peace. This can happen when all belligerents become exhausted or when one wins decisively….

A cease-fire tends to arrest war-induced exhaustion and lets belligerents reconstitute and rearm their forces. It intensifies and prolongs the struggle once the cease-fire ends—and it does usually end….

Read more at Foreign Affairs

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Markets move to Risk-Off

Bitcoin broke support at $64K, warning that financial markets are moving to risk-off . Traders and investors reduce their exposure to risk and focus on protecting their capital. Follow-through below $62K would confirm, warning of a sharp fall (in BTC) and a stock market correction.

Bitcoin

The 10-Year Treasury yield has climbed to 4.67%, confirming our target of 5.0%.

10-Year Treasury Yield

The Japanese Yen fell to 154 against the Dollar, increasing pressure on the Bank of Japan to loosen the cap on long-term JGB yields — to protect the Yen. The result of such a move would be an outflow of Japanese investors from the US Treasury market, increasing upward pressure on UST yields and downward pressure on the Dollar.

USDJPY

Fed Monetary Policy

From CNN:

The US economy’s enduring strength and a “lack of progress” on inflation means the central bank likely won’t cut interest rates at its upcoming policy meeting just two weeks away, Federal Reserve Chair Jerome Powell said Tuesday.

“The recent data have clearly not given us greater confidence” that inflation is headed toward the central bank’s 2% goal, Powell said during a moderated discussion hosted by the Wilson Center. Instead, he said, there are indications “that it is likely to take longer than expected to achieve that confidence.”

Stocks

The S&P 500 broke support at 5100, warning of a correction. Lower Trend Index peaks reflect selling pressure. Our target is 4950.

S&P 500

The Equal-Weighted Index ($IQX) continued its downward path after breaking support at 6650, presenting a target of 6250.

S&P 500 Equal-Weighted Index

US Consumers

Real retail sales ticked up in March to remain on trend.

Real Retail Sales

Light vehicle sales also remain reasonably strong, at 15.5 million units (annualized) in March.

Light Vehicle Sales

Gold & the Dollar

The Dollar Index climbed above 106, strengthened by safe haven demand and the appeal of higher long-term yields. Our target is the October 2023 high at 107.

Dollar Index

Gold is again testing resistance at our target of $2400 per ounce, currently at $2383. The Shanghai Gold Exchange continues to display a premium on its international gold contract (iAu99.99) at 558.3 Yuan which translates to $2399 per Troy ounce (31.10348 grams). The domestic contract trades at an even higher price of 569 per gram but is subject to capital controls. The price premium should ensure a constant inflow of physical gold from other exchanges to China for as long it is maintained.

Spot Gold

Silver retraced from resistance at $29 per ounce and is testing support at $28. The lower Trend Index peak warns of selling pressure. Breach of $28 would warn of a correction to $26. Breakout above $29 is less likely in the short-term but would signal a fresh advance, with a medium-term target of $34.

Spot Silver

Crude & Commodities

Brent crude is in a narrow consolidation (pennant) at $90 per barrel. Continuation is likely and would test resistance at $96 per barrel.
Brent Crude

Nymex crude has retraced to test short-term support at $85 per barrel. Respect is likely and would indicate an advance to our target at $90.
WTI Light Crude

Conclusion

Geopolitical risk dominates, with an Israeli retaliatory attack on Iran expected before the end of the month.

Rising crude oil prices are likely to increase inflationary pressure and the yield on long-term Treasuries, with the 10-year yield expected to test 5.0%.

Safe haven demand from investors is concentrated on Gold, with bond prices falling and stocks warning of a correction. We expect a short retracement to test support levels but respect is likely and would signal another advance.

Bitcoin is diverging from Gold as investors grow more risk averse. Breach of support at $62K would confirm a correction, with support expected at $52K.

Acknowledgements



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Iran attacks Israel

Markets are overshadowed by news that Iran directly attacked Israel in retaliation for the bombing of its embassy in Damascus which killed two high-ranking Iranian generals.

Iran

This is a significant escalation in Iran’s on-going proxy war against Israel.

Russia and its allies are emboldened by the US failure to support Ukraine and are stepping up their attacks on Western allies.

Iran

Mick Ryan (retired Australian Maj. General) writes:

…What is Iran’s ultimate goal here and its strategy to achieve it? This is a major shift in the way the Iranians have attacked Israel for years. Proxy forces are normally Iran’s preference in order to keep it at arm’s length from a potential Israeli response. Why has it decided on such a drastic course change in its strategy to confront Israel?

He lays out four options for retaliation — ranging from no direct response to a massive hammer blow to deter a repeat — and concludes:

All of these are possible in the hours and days ahead. All have advantages, as well as considerable disadvantages, for the Israelis. But one thing is certain, the concept of ‘re-establishing deterrence’ against Iran will be an important guiding idea.

And, it is uncertain whether the Iranians are really prepared for what they may have unleashed against their country and the wider region.

Flight to Safety

Given the high level of uncertainty, we can expect a significant flight to safe haven assets. Stocks are expected to weaken, with the S&P 500 breaching support at 5100 to signal a secondary correction.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) has already warned of a market move to risk-off after breaching support at 6650. A test of support at 6400 is likely.

S&P 500 Equal-Weighted Index ($IQX)

The Russelll 2000 Small Caps ETF (IWM) has similarly breached support at 200, warning of a correction to 190.

Russelll 2000 Small Caps ETF (IWM)

Brent crude is expected to test resistance at $96 per barrel.

Brent Crude

10-Year Treasury yields are already retracing and headed for a test of new support at 4.35%. Respect is likely, however, and would confirm an advance to test resistance at 5.0%.

10-Year Treasury Yield

The Dollar Index may not follow 10-year Treasury yields, with safe haven demand fueling a test of 107.

Dollar Index

Gold saw significant profit-taking on Friday after reaching our target of $2400 per ounce earlier in the day. Retracement is likely to respect support at $2300, followed by a strong advance fueled by safe-haven demand.

Spot Gold

The international contract on the Shanghai Gold Exchange (iAu99.99) is trading at 562 Yuan/gram. This equates to a USD price of $2415 per troy ounce — a sizable premium over Friday’s close at $2344.

Silver has retraced to test support at $28 per ounce. Respect is likely, signaling a test of resistance at $29 per ounce. Breakout above $29 would offer a long-term target of $36 per ounce.

Spot Silver

Bitcoin is consolidating below resistance at $72K. Breakout is likely and would offer a target of $92K, while reversal below support at $64K would warn of a correction to test $52K.

Bitcoin

Conclusion

Escalation in the Iran-Israel conflict is likely to drive crude oil prices to new highs as geopolitical risk rises. Inflationary pressures are expected to climb as a result, reducing the possibility of Fed rate cuts this year.

Other geopolitical factors could intervene, including the Saudis increasing production to hold crude oil prices below $100 per barrel. Above $100 is considered unsustainable by many producers and believed to lead to sharp falls in demand as the global economy contracts in response.

Financial markets, stocks and precious metals are likely to be dominated by safe-haven demand in the weeks ahead. A shift from small caps — and even the broad S&P 500 to the largest “magnificent seven” tech stocks — is expected as investors grow increasingly risk averse. Demand for Gold & Silver is expected to rise. The Dollar is likely to strengthen, along with short-/medium-term Treasuries. But long-term yields are unclear because of conflicting inflation/safe-haven pressures.

Acknowledgements

 

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Thoughts on Israel

We express our sympathy for the people of Israel who have suffered a brutal attack from HAMAS and its backers.

An act of such barbarity is bound to evoke a response and lead to further escalation of violence in the region. But that seems to be the intention.

Martin Indyk, former US Ambassador to Israel (1995-1997 and 2000-2001) and special envoy under President Obama for Israeli-Palestinian negotiations (2013-2014), was asked why this occurred now, after progress seemed to be made on an Israel-Palestine settlement:

I think you have to consider the context at this moment. The Arab world is coming to terms with Israel. Saudi Arabia is talking about normalizing relations with Israel. As part of that potential deal, the United States is pressing Israel to make concessions to the Palestinian Authority—Hamas’s enemy. So this was an opportunity for Hamas and its Iranian backers to disrupt the whole process, which I think in retrospect was deeply threatening to both of them. I don’t think that Hamas follows dictation from Iran, but I do think they act in coordination, and they had a common interest in disrupting the progress that was underway and that was gaining a lot of support among Arab populations. The idea was to embarrass those Arab leaders who have made peace with Israel, or who might do so, and to prove that Hamas and Iran are the ones who are able to inflict military defeat on Israel.

There are talks going on regarding a peace deal between Israel and Saudi Arabia, and conversations about U.S. security guarantees for Saudi Arabia. In all likelihood, a primary motivation for Hamas and Iran was a desire to disrupt that deal, because it threatened to isolate them. And this was a very good way to destroy its prospects, at least in the near term. Once the Palestinian issue returns to front and center, and Arabs around the Middle East are watching American weapons in Israeli hands killing large numbers of Palestinians, that will ignite a very strong reaction….

….And in terms of escalation, the party to watch most closely is Hezbollah. If the Palestinian death toll rises, Hezbollah will be tempted to join the fray. They have 150,000 rockets they can rain down on Israel’s main cities, and that will lead to an all-out war not just in Gaza but in Lebanon, too. And everybody would get dragged in that situation. (Foreign Affairs)

Conclusion

The aim of the attack was to provoke a violent retaliation which would disrupt an Arab-Israeli peace accord.
Starting another war would play into the perpetrator’s hands.
Netanyahu prides himself on being cautious. Now is the time to show restraint, bolster Israel’s defenses and continue to pursue peace in the region — which would sideline HAMAS and its Iranian backers.

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Afghanistan: The worst kind of cowardice

I would have expected the former Swedish prime minister to have a better appreciation of the challenges political leaders face when confronted with a choice like Afghanistan:

Carl Bildt

Colin Twiggs

The media focuses on the 12,000 casualties and more than $1 trillion spent over the past 20 years. A complete waste. Especially when you consider the end result. But the alternative is even worse: to continue spending good money after bad, wasting more lives unnecessarily in the process. Your first duty as a leader is to avoid another young soldier returning home with his/her legs blown off or with brain trauma from an IED.

Sacrifice is necessary when there is a clear and attainable end goal in mind. But the worst kind of sacrifice is the kind politicians make because they don’t want to take a hit in the ratings. That isn’t courage, it’s cowardice.

A long, long time ago I served in a counterinsurgency operation where one of my fellow 18-year olds had his legs blown off above the knee when his horse stepped on a landmine. He died several years later. I often think of him in times like this because the conflict has long since been forgotten, the outcome was inevitable and time has marched on.

No one has the right to ask young men and women to serve in those kind of circumstances. Not you, not me, nor Joe Biden.

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Echoes of the Past: Syria, Chemical Weapons, and Civilian Targeting

Everyone should read this as a reminder of the brutality that states may employ for political ends, whether Ethiopia (1935), Chechnya (1995), Iraq (1998) or Syria (2017). Chemical weapons such as sarin or mustard gas leave horrific injuries, but any deliberate targeting of civilians — such as bombing of hospitals and residential neighborhoods — should IMO be treated as a war crime.

Luke O’Brien is a U.S. Army officer assigned to Aberdeen Proving Ground and is currently a Countering Weapons of Mass Destruction Graduate Fellow at National Defense University:

…..Perhaps the most notorious example of this from recent memory, however, was the Iraqi chemical attack on the Kurdish town of Halabja in March 1988, as part of the Anfal Campaign at the end of the Iran-Iraq War. This attack struck the small Kurdish village with both conventional and chemical bombs, including sarin, just as Assad’s forces would nearly 30 years later. The first attacks used normal high-explosive bombs, which both drove civilians into basement shelters as well as broke open the villages windows and doors. These initials attacks were then followed up with chemical munitions, which quickly filled the basement shelters and killed their occupants.

Such brutality was intentional. The attacks were intended to break the back of the Kurdish peshmerga militia by depopulating its support. Commenting on the matter at the time, Iraqi Gen. Ali Hassan al-Majid bragged that he would “kill [all the Kurds] with chemical weapons.” The chemical bombardment of Halabja had its desired effect, with a stream of surviving civilians abandoning the town and fleeing to nearby Iran. This use of chemical weapons, moreover, had another added benefit: driving away civilians and insurgents who had become numb to the effects of conventional weapons…..

Read more at: Echoes of the Past: Syria, Chemical Weapons, and Civilian Targeting

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No Plan? No Strategy? No Problem! Syria and Trump’s Russia Policy

Michael Kofman is an Analyst at CNA Corporation and a Fellow at the Wilson Center’s Kennan Institute:

….Past American attempts at coercive diplomacy with Russia have typically lacked actual coercion, and a theory of how to gain leverage over Moscow. It will be rather startling if 59 cruise missiles turn out to be the answer to this problem. Thankfully, the previous administration tested a lot of theories that didn’t work, from empty threats at the United Nations, to disproven assumptions on what influences Russian behavior, to narratives about quagmires. It would be best for Trump’s White House not to set us on this journey, mounted on that very same broken wheel (or one just as broken in a different way).

In a contest of wills, Trump needs a plan to establish coercive credibility rather than hoping to scare the Russians with expensive fireworks. The number one mistake previous administrations made with Moscow is that, rather than deal with the Russia that is, they all imagined a Russia that suited them more, and then tried to have relations with that imaginary country.

The reality is, this administration’s only current leverage with Russia is the notion inside the Kremlin that a cooperative agenda with the United States is still possible. That’s a dubious proposition which offers the U.S. some advantages. Russia still hopes that there are carrots the United States might offer, or at the least it could get respite in the current confrontation and consolidate gains. If the administration is able to drag out this perception, rather than demonstrating that the White House is rapidly reverting to classical archetypes that Moscow anticipates, then there is an opportunity to obtain concessions.

Given that a cooperative agenda between the United States and Russia is well-nigh impossible, where does that leave us?

Source: No Plan? No Strategy? No Problem! Syria and Why Trump’s Russia Policy Is Off to a Rough Start

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