PremiumHartnett: US Politics Dictate March De-escalation To Iran War
Always a pragmatist, Michael Hartnett cuts to the chase in his latest Flow Show note (available to pro subs), which directly addresses the most important question on Wall Street these days: how long will the Iran war last?
While many are now speculating that the war in Iran will drag on for months as the decapitation strike on US Iran - namely killing the Ayatollah and wiping out the top political and military leaders - did not generate an immediate result, Hartnett counters that US politics suggest a March de-escalation of Iran war. That's because Trump's approval on economy (40%) and inflation (36%) are back at the lows...
... and now the president must reverse a 45% surge in US oil prices, 15% jump in gasoline prices, which means a lengthy Iran conflict is not feasible. The market is facing a similar quandary: according to the BofA CIO, a recovery in Trump approval rating ahead of the midterms is needed for Q2 upside, or as he puts it "bulls want “populist capitalism” not “populist socialism”.
Once de-escalation comes, what then? Hartnett writes that de-escalation (+ Trump-Xi trade deal) = sell oil $90/bbl, sell US$ >100 DXY, buy 30-year UST @ 5% + risk troughs March; That said, the BofA strategist expects no new equity highs without bear positioning and policy panic to reverse peak liquidity. He also notes that a "short war renews bid for inflation boom beneficiaries… commodities, EM small cap as the US dollar bear market resumes."
To be sure, the clear downside risk scenario remains Iran escalation (as Iran/Israel play endgame/US all-in to secure oil supply to power US AI supremacy): here, the asset allocation shifts to beneficiaries of extended conflict: oil, US$, US tech, global defense at expense of oil importers with minimal energy equity exposure, such as Korea, Japan, Europe.
For Hartnett, the biggest threat under this scenario is to the bank "bull leadership" in Japan and Europe.
As is customary, the strategist then takes a look at the latest weekly flow data, where the highlights are $19.7bn inflows to bonds, $11.5bn to stocks, $5.6bn to cash, $1.9bn to crypto, $1.8bn from gold (the largest outflow since Oct’25), and also points out the biggest outflow from bank loans ($0.9bn) in 3 months ("but level of outflows nowhere near systemic event capitulation of 2018 and 2020) offset by continued sizabale inflows into EM ($12.6bn) equities (Chart 15) as he sees "no capitulation in EM exposure" (much more in the full report), before shifting to his commentary on market corrections. This is how Hartnett frames it:
On Corrections: Corrections caused by exogenous shocks at time of excess bullishness typically end once:
- 1) the “oversold” trough (software, MAGS, private credit, bank loans, bitcoin),
- 2) the “overbought” sold (gold, semis, metals, EM, Europe, banks)
3) the “safe havens” lose bid (oil & US dollar)
Hartnett believes that price action hints 1 and 2 are starting to happen, but oil & dollar are needed to give all-clear. That said, don’t expect big trading upside from here given yet to see proper price flush lower (e.g., SPX <6600), and positioning is still excess bullish, with no policy panic (bar Korea).
For the Bank of America strategist, the key asset to watch is the US dollar, which is the best global liquidity barometer: a decisive DXY index break higher >100 would mean the “peak liquidity” theme is deepening the December peak in global central bank cuts, pricing out ’26 rate cuts (probability of June 17th Fed cut was 100% Jan 1st, now 37%), yield curve flattening & potential inflationary oil shock.
Next, Hartnett moves to that other "C", namely Credit Events.
On Credit Events: Here there are some good news: the IGV software ETF peaked Sep 23rd when Nvidia announced $100bn investment in OpenAI; this week Nvidia said a $100bn investment is “not in the cards,” and the $30bn financing might be last. This is good news, because according to Hartnett, any sign of deceleration in the exponential AI capex growth = best catalyst to reverse “short tech bonds” trade (led by the blowout in Oracle CDS spreads)...
... and “long SOX-short IGV” trade (“AI awe>AI poor”) trade. More big picture, a trough in software = trough in private credit & bank loans. Until then, Hartnett echoes what he said last week, namely that it is crucial for IGV to hold $80 & BKLN to hold $20 Feb lows (as a reminder, bank loans traded close to “credit event” territory earlier this week).
Shifting gears, Hartnett next repeats his long-standing view on the 2020s, claiming that the 2020s will represent an inflationary boom not stagflationary bust.
That's due to political populism (note recent UK electoral shift from established to insurgent parties)...
... reversal of globalization via tariffs/immigration, fiscal excess, Fed acquiescence, asset/wealth inflation because stock market too big to fail… are all inflationary but will also be offset by government intervention to prevent high bond yields. Hartnett sees this playing out via weaker US$ not higher bond yields.
Meanwhile, the inflationary boom beneficiaries are commodities, real assets, international stocks, small cap; as for the bull market in stocks, it resumes once clear Iran baseline not protracted conflict, oil capped at $90//bbl and no prolonged conflict (but Hormuz closure, Iran attacks regional oil infrastructure, collapse of Iran output = oil >$100-120/bbl).
Hartnett closes this week's Flow Show with what he says is the closest analog for the 2020s, which regular readers are aware is the 1970s, a period he calls an "imperfect but closest analog for 2020s." 1970s played out as follows:
- 1970-1972: Nixon's 1st term of geopolitical realignment (end of US involvement in Vietnam War, Nixon visit to USSR & China), trade war (Nixon tariffs on Japan), pro-cyclical, shock therapy fiscal & monetary policies, US dollar debasement (end of Bretton Woods), Fed debasement (Nixon replacement of Martin with Burns) & political subservience; policy & markets… after short 1969 recession, massive easing of financial conditions in 1970-1972 (Fed funds 9% to 3%, US Treasuries 8% to 5%, US dollar -10%) to create pre-election “boom” coupled with aggressive price & wage controls to drive inflation from 6% in Dec'69 to <3% in '72; equity markets boomed (up >60%) led by “Nifty Fifty,” growth stocks, energy & consumer sectors;
- 1973-1974: early 1970s boom followed by big bust in '73/'74 as boom caused inflation to break loose (up from 3% to 12% by end-'74), “price controls” failed, Fed forced to hike rates aggressively (6% in '73 to 13% in '74), which with '73 oil shock caused recession; stocks fell 45% from Jan'73 to Dec'74, yields rose from 6% in '73 to >8% in Sep'74;
- 1975-1976: end of Vietnam War, end of Nixon presidency (resigned in Aug'74, Ford assumed presidency through 1977), falling inflation after 1st wave (CPI from 12% to 5%); rally in assets driven by Fed pivot (cut rates from 9% to 4%), yields down from nearly 9% in Sep'75 to <7% by Dec'76; rebound after deep recession and bust that caused end of Nifty Fifty saw new equity leadership in H2'70s of small cap>large cap and value stocks>growth stocks;
- 1977-1980: 2nd wave of inflation (CPI 5% to 15%) driven by 2nd oil shock (Iranian Revolution, Iran hostage crisis); stocks fell 26% from Dec'76 to Feb'78, US Treasury yields up from 7% in Jan'77 to 14% by Feb'80, gold outperformed once more; 2nd wave of inflation ultimately ended by Volcker Shock (big monetary tightening from 1979 to 1982).
