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- [00:01]
A
Welcome to Thoughts on the Market. I'm Michael Zezas, Deputy Global Head of Research for Morgan Stanley.
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B
And I'm Mariana Salvatore, Head of Public Policy Research.
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A
Today we're discussing the U. S. Iran ceasefire's key uncertainties, consequences and what we're watching for Next. It's Wednesday, April 8th at 11:00am in New York. Okay, let's start with the current situation. The US and Iran have agreed to a provisional ceasefire. Two weeks tied to follow on talks and the reopening of the Strait of Hormuz. Markets so far are treating this as a de escalation, but not a clear resolution.
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B
That's right. And I think the key framing here is this is a pause, not a peace deal. And in the near term I would not assume things are suddenly stable. We still have some key uncertainties around how the ceasefire deal is going to be implemented and as well as how negotiations will begin to take shape.
- [00:57]
A
Right, and that's important. It seems like Iran's reported 10 point plan for the ceasefire includes some elements that might be non starters for the us. Some things around sanctions and unfreezing of assets. And so there's lots of ways that there could be some re escalation in the near term.
- [01:19]
B
Okay, so that's the near term. Fragile, noisy and still pretty headline driven. But let's try to think about this a little bit further out. How are we thinking about the medium term?
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A
Yeah, so thinking a little bit further out, it seems to us that ceasefire and Strait of Hormuz reopening should continue to progress because the incentives are widely shared across the key actors involved. So the US's incentive to effectively be done with the conflict is pretty well understood. There's domestic political incentives and economic incentives. There's ways to potentially explain away some of the compromises the US might have to make around the Strait of Hormuz, around sanctions, and maybe point to some incentives to work with partners in the region over time to diminish the importance of the Strait of Hormuz as a choke point. Iran's incentive is pretty clear to preserve its regiment. And another actor here which appears to be increasingly important is China, which has reportedly been involved in expressing its preference for de escalation. And that's pretty important because China has a lot of leverage on Iran given its economic relationship with the country.
- [02:36]
B
So starting with these negotiations, it seems like as you mentioned before, there's still a lot of gaps between what the US side and what the Iranian side is asking for. But let's put that in the context of the ceasefire Even if it were to hold, that doesn't necessarily translate to stability, right?
- [02:52]
A
Yeah, I think that's right. So if Iran were to start rebuilding its military assets, in particular its nuclear program, at some point in the future, we'd probably come back to a similar point where Israel and the United States might find their ability to project that power to be intolerable. And what we don't know right now is if any type of deal is possible that can mitigate those very long term concerns. So even if commodities start flowing through the Strait of Hormuz at a rate that is similar to what it was before the conflict started, it seems like there will be this overhang of concern that that could shut down at any moment's notice if the US And Israel and other actors in the area become concerned again with Iran's power.
- [03:47]
B
So that overhang you're talking about actually does have some real economic impacts. One way to frame this is kind of like a lingering tax on the global system. We see that through the oil market. Right. So we think of this as a structural risk premium on oil. Our strategist, Martin Ratz thinks that even in a de escalation scenario, you're not getting back to that world of 65, $70 oil. This strait of Hormuz will continue to be a critical choke point that doesn't necessarily go away overnight. And maybe over time you could see some mitigation, construction of new pipelines, alternative routes, et cetera. But in the interim, that risk premium feeds through to energy prices, shipping costs, and ultimately food and broader supply chains, which is something that Chet and Aya has been flagging in Asia for quite some time.
- [04:32]
A
I think that's right. And so in highlighting that the straight of four moves is a critical choke point for the global economy and for supply chains generally, it's a reminder of a problem that's been on display for the last 10 years, which is that there are supply chain choke points all over the place. When you start thinking about the security needs of the US and other actors throughout the globe, it underscores this dynamic where multinationals are going to have to rethink and are already starting to rethink their supply chains and whether or not they need to build in what our investment bankers have been calling an antifragile supply chain strategy. We can't just solve for the cheapest cost of goods and cheapest transit. You have to wire up your supply chains in a way that that can survive geopolitical conflicts. And while there's some extra embedded cost that comes along with that, well, they're more reliable, so it's more efficient over the long run. Of course, it costs a lot of money to rewire your supply chains. And so that's tied into this opportunity around capital expenditures going into proving this out. And so investors should be aware that there are plenty of sectors which will have to participate in effectively being part of rebuilding those supply chains.
- [05:58]
B
Yeah, so the way we're framing this is, this is another data point kind of in that trend toward a multipolar world. We've seen certain geopolitical events accelerate that transition. Russia, Ukraine, for example, the pandemic. And this is just sort of another example in that same direction. And some of the sectors that we think are structural beneficiaries here, obviously defense in particular in Europe and industrials here in the us. Chris Snyder has been doing a lot of work on reshoring how we're seeing that pick up, and we think that probably continues. But as we're speaking about the US and what this could mean, let's bring this back to the AI angle, because I think that's where this all really connects in maybe a less obvious way. Near term, we're thinking about the financing implications here as pretty modest. Unless we get a major re escalation or a rupture of the ceasefire, it shouldn't really change capital availability in a meaningful way. But this could affect where capacity gets built.
- [06:48]
A
Yeah, that's right. And over the past year, there's been a lot of news about the US engaging in the Middle east with partners to build AI capacity via data center capacity, because there's also plenty of energy in the area to fuel those data centers. But those data centers, as an infrastructure asset, and an economically valuable one at that, potentially become military targets when they're built. So there is a consideration here after this conflict about whether or not those things can be built or be relied upon. And it is a critical part of the US's strategy to build compute capacity in the aggregate with allies. And increasingly they've been looking to the Middle east as allies and in an AI build out.
- [07:43]
B
So if that becomes more challenging and you see persistent instability, for example, in the Middle east, you're probably going to see more demand pushed toward domestic US data centers. And something that we've been highlighting has been not only the kind of pressures on the capital side, but also, you know, the bottlenecks that are very real, like power permitting, labor, equipment, and political resistance, which we've talked about on this podcast as well. We're seeing a lot of constraints so it's not really feasible that the US is going to able to fully substitute that Middle east capacity.
- [08:13]
A
So I think the read through here is that the US is still on track to build the compute capacity that it needs. The capex that's going into that that is helping the US economy grow this year is still very much intact. It raises some potential future questions about how quickly the US can build out, but it's unclear if that matters in the near term to A both the build out and B the productivity that can come from the current build out.
- [08:42]
B
And I think a really important consequence of what you're describing has to do with the US China dynamics. So if the US is for example, seen as a less reliable security guarantor, then you may see some of the Gulf countries potentially deepen their economic alignment with China at the margin. And that's something that could be really relevant for the upcoming US China summit next month. Remember that was postponed from initially it was towards the end of March. Now it seems to be around the middle of May. So that's a really important catalyst that we're keeping an eye on. For now. That's a little bit further out near term, of course we'll be watching things like military buildup in the region. Any indications on how exactly the Strait of Hormuz will be managed from here and how these negotiations progress over the next two weeks. As far as the equity market is concerned, it appears that the worst of this risk is behind us from a rate of change perspective. So our strategists think you should start to see leadership emerge from the sectors that were doing well into this conflict, namely cyclicals like financials and industrials leading the way from here.
- [09:40]
A
Well Arianna, thanks for taking the time to talk.
- [09:42]
B
Great speaking with you, Mike.
- [09:43]
A
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B
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