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March
20, 2003, 6:30 a.m.
“War
Rally” I
That
was stage one of Iraq-related re-pricing.
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 n
case you missed it, the first stage of the Iraq-related re-pricing of
the financial markets just hit. Oil and bond prices fell while equities
and the dollar rose. Still, the current level of uncertainty is still
seriously distorting market-based prices as well as perceptions of the
economic outlook — and this won’t be resolved for several weeks.
Rather
than a “war rally,” the recent re-pricing is a logical response to the
narrower timeframe for Iraq’s disarmament — March. The next stages
of the Iraq-related re-pricing will depend on the many remaining Iraq
uncertainties. These include:
—
Turkey’s role in the conflict.
— Terrorism
as the war starts.
— The length
of the war.
— U.S. release
of SPRO, its strategic petroleum reserve (not a certainty).
— Iraqi use
of chemical and biological weapons.
— Any lasting
damage to Iraqi oil and oil production.
The financial markets
will only want to price in these risks as they become known. Also, not
on this list is the future of the United Nations, and the expense or difficulty
of the Iraq rebuilding effort.
In coming weeks,
there should be several upgrades in the consensus economic outlook, somewhat
paralleling the re-pricing process. With the dollar now at a relatively
neutral value (locking in a reflation), some of the key Iraq-related economic
variables are:
—
The price of oil several days into the war. This makes the SPRO
release important, as well as Saddam’s ability to destroy or contaminate
Iraqi and Kuwaiti oil. The U.S. faces a trade-off between using SPRO to
get a much lower price of oil now versus its desire to work with Saudi
Arabia and Arab oil producers (who have increased their oil production
sharply in preparation for the war.)
— The
war’s direct impact on business confidence and investment. Depending
on terrorist incidents and the length of the war, the economy may well
enjoy a quick decline in risk aversion and a quick rebound in investment
activity. In particular, pent-up investment, a 40-year low in the Fed
funds rate, and a near-record low in the level of inventories relative
to sales are all economic positives.
— President
Bush’s popularity. Tracking this is one way to measure whether the
war is perceived to be a success.
— The
probability of the U.S. eliminating the double taxation of dividends.
This is a critical factor in the outlook. The probability will change
fast based on Bush’s popularity and the length of the war.
—
Mr. Malpass is the Chief Global Economist for Bear Stearns.
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