Trading Desk Talk

Zombie

With over 1.8 billion views on YouTube, the anti-war song “Zombie,” by The Cranberries, is an undisputed mega hit; in 2018, Bad Wolves even covered the song with a heavy metal update. Both the original and the remake remind us of the tragedy of war.

We closed out the first week of the conflict in Iran with global uncertainty on the rise and financial markets behaving skittishly. Tehran is also scheduled to appoint a new leader soon (presumably one who is more pro-Western than Ayatollah Khamenei). Last week, generic credit default swaps on investment grade and high-yield corporate bonds widened by over 18%, while domestic stocks were down 3% from their January 28 peak (Figure 1). The economic topic of the week, however, centered on the spike in oil prices, with West Texas Intermediate crude futures rising from $65/barrel at the end of February to $88/barrel on Friday’s close. Brent crude contracts, Europe’s benchmark, followed suit, going from $71 to $91 a barrel.

Nevertheless, fears of soaring oil prices as a result of the Iran war should be taken with a grain of salt. While the commodity rose in the early days of this war, history suggests that war itself isn’t a good predictor of the direction of oil prices. Figure 2, which tracks the price of crude oil throughout the beginning of the last three major U.S. wars in the Middle East, shows no discernible pattern.

The Gulf War was short-lived and characterized by a price spike and then retracement. The long war in Afghanistan was characterized by a large upswing in oil prices, which later fully retraced. Yet the cause of the rise in price around 2004 was not fighting, but rapid industrialization in China, combined with constrained supply. Meanwhile, the subsequent drop in prices around 2014 was due to the U.S. shale revolution, which led to a surge in production, along with OPEC’s decision to increase supply by keeping its foot on the gas (pun intended). In both cases, the broader macro environment dictated the direction of oil prices.

While oil in isolation is seemingly less relevant to our market, it comes heavily into play via inflationary pressures and subsequent monetary policy. For example, energy’s direct contribution to the headline Consumer Price Index (CPI) is 6.38%, according to the Bureau of Labor Statistics. Energy’s downstream effect, however, has oil hitting above its weight class, since energy can be considered an input cost to other goods and services. Consider a hair stylist who may need to adjust prices in order to cover, say, the increased cost for hair chemicals (which are dependent on oil to produce) and transportation (for both hair products at the salon and for the gasoline used to commute to work).

Farmers offer another example. Agriculture requires nitrogen-based fertilizer—roughly 88% of the nitrogen produced in the U.S. is used for fertilizer—which, in turn, is heavily dependent on natural gas. Natural gas prices are thus highly correlated with fertilizer costs—and, therefore, affect farmers’ profits (and prices for consumers). Again, freight and transportation costs will be correlated to oil/gasoline prices, which could affect the consumer downstream.

In short, the broader energy complex is something that could become worrisome, especially if the war drags on and oil continues its upward trajectory. Figure 3, which charts year-over-year changes in oil prices and headline CPI, illustrates a weak, positive correlation between the two.

While inflationary pressures have plateaued recently (albeit above the Federal Reserve’s 2% target), this may not last long now that the war in Iran has effectively closed the Strait of Hormuz. About 20 million barrels of crude oil and petroleum liquids passed through the Strait per day in recent years, according to the U.S. Energy Administration. That amount represents about one quarter of global consumption (although nearly 80% of that oil volume is destined for Asian markets).

Some pundits have called for a flight to quality as volatility rises. But again, with oil being more dependent on the macro narrative instead of saber rattling, financial markets seem to look through the noise. Figure 4 charts the 10-year Treasury yield, indexes major recent wars to their first day, and then calculates the change in yield from that point forward. On average, there is no movement across wars. In other words, the macro trend that was driving the Treasury market before the given war continued to drive it throughout the duration of the war.

Fed officials should, of course, understand that upwardly swinging oil prices can be inflationary and that an exogenous shock, like a war, can cause near-term pain in inflation. For example, CPI jumped from 4.4% pre-Gulf War to 6.0% before the war ended, thereby enabling a drop in both oil and inflation after. Below, we summarized recent commentary from Fed officials on this point:

• Tom Barkin, President of the Richmond Fed, said that the central bank’s response to the U.S.-Israel war with Iran will depend on its length. “Textbook monetary policy would be you look through a short-term shock, but you don’t look through a long-term shock … I think that’s a lot of the assessment people are going to have to make.”
• Stephen Miran, Fed Governor, maintained his uber dovish tone. “When you look at the totality of labor market data, there’s still evidence to me that it needs more support from monetary policy.”
• Neel Kashkari, President of the Minneapolis Fed, said that the attacks on Iran make him less certain about the rate path, adding that the key question right now for inflation is how persistent higher energy prices will be.
• John Williams, President of the New York Fed, said that the economic fallout from U.S.-Israeli attacks on Iran hinges on how long they will affect asset prices, especially the price of oil; he added that the impact on financial markets was so far “reasonably muted” and that oil prices have moved up, but not yet “in a dramatic way.”

Fed officials next meet March 17–18 and have signaled that they’re likely to hold rates steady for a second straight time, as they seek more progress on inflation. Nevertheless, last Friday’s abysmal employment report for February (92,000 job losses) does support some of Miran’s dovish comments. If that side of the dual mandate continues to deteriorate, it would put the Fed in a tough spot with a weak labor market and rising inflation.

FROM THE DESK

Agency CMBS — Geopolitical tensions weighed on risk assets broadly, but agency CMBS held in well this past week. Ginnie Mae spreads were flat to two basis points wider and Fannie Mae DUS spreads were largely unchanged. Swap spreads tightened week over week, which helps some banks that tend to look for large FTIO origination. We expect that structure to garner stronger bids if this trend persists.

Municipals — AAA tax-exempt yields increased throughout the yield curve on a week-over-week basis. Tax-exempt yields rose last week, as unrest in the Middle East and soaring oil prices sent Treasury yields higher. But the municipal bond market continues to benefit from strong bond fund inflows and a manageable primary new issuance calendar in early 2026. Municipal bond funds took in $1.4 billion last week, the tenth consecutive week of inflows, bringing the year-to-date total to $14.2 billion. The average weekly inflow for 2026 is over $1.42 billion. About 19% of last week’s inflows were directed into high-yield funds. 

The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.