Oil prices are rising again after falling most of this year. Brent Crude was about $88 a barrel a month ago. Today it's around $105. That's a nearly 20% rise simultaneous with a deceleration in global growth expectations, decreasing oil demand, the collapse of many two-year sovereign yields, and short to long bond spreads concurrently falling below the 200-basis point minimum necessary for the global financial system to operate properly.
There are no economic models to address these circumstances with monetary or fiscal policy. There are no financial models designed to account for negative nominal rates -- especially ones that have been extended as far out as two years.
This process has occurred very quickly. Although Japan has had very low nominal sovereign yields across its curve for years, even they are positive. Within the past few months, many countries' two-year yields have declined well below those of Japan. Switzerland is at -38 basis points, Germany -4, Denmark -30. Finland, Austria, and the Netherlands are at zero. In comparison, even Japan is at 10 basis points.
A confluence of events has caused these issues to arise. The European debt crisis and a concurrent worldwide economic slowdown is the catalyst for collapsing yields, while the simultaneous oil price increase is almost certainly a harbinger of increasing expectations of a military conflict between the U.S. and Iran.
Real Money's Glenn Williams recently wrote about these preparations. The geosynchronous economic slowdown and concurrent untested record low, negative sovereign yields, and collapsing spreads quickly take precedence over any real concerns about Iran's nuclear goals as the catalyst to accelerate plans for a military conflict.
In the past month, the International Monetary Fund, World Bank and most of the world's central banks have reduced expectations for global and regional growth for the next few years. Accentuating this issue is the U.S. presidential election, commensurate with another federal budget battle and increasing state solvency concerns.
Economics is politics, and war is economics by other means.
Although the coincident economic issues in Europe and the U.S. are probably accelerating the timeline for military conflict with Iran, timing is also an issue for Iran. Economic sanctions have debilitated the Iranian economy. Consumer staples are increasingly scarce and inflation is rampant. More importantly, the Iranian regime's primary consideration may be the cost of conflict with an Obama-led U.S. compared to what might unfold under a Romney administration. A loss for Obama in November will almost certainly be because of the economy. The need for Romney to address this would be even greater next year than it is for Obama now.
As this is plays out, stocks of the largest U.S. defense contractors have been reflecting more caution about the budget battle and the impact on government spending than on the prospects for federal spending to wage a war that may be unilaterally decided by the president. Lockheed Martin (LMT), Northrop Grumman (NOC), Boeing (BA), Raytheon (RTN), and SAIC (SAI) are all trading near where they've been most of this year, even though they have dividend yields of between 2.5% and 4.5%. Although their performances are similar to those of large utilities, they may get an immediate boost from a military conflict with Iran that looks to be increasingly imminent.