2-Week Ceasefire, Then?

 The 2-week ceasefire between Iran and the U.S. is a big breakthrough, but what happens after 2 weeks?  

Figure 1: Iran Key Issues

Source: Media sources from Iran, US, Pakistan

While both sides are claiming victory in the PR war, the ability to agree a 2-week ceasefire is important.  We have argued that president Trump has been looking for an off ramp, given the war impact on gasoline prices and his falling popularity rating before the key November midterm elections.  However, Iran’s decision to accept Pakistan’s proposal for a 2-week ceasefire is their first major compromise and suggested Iran now sees merit in negotiating and stopping the hostilities.  Though Iran has been hurt severely from a military viewpoint, it has demonstrated leverage in the Straits of Hormuz and via asymmetric attack on Gulf countries.  Key points for the next 2 weeks and beyond are as follows:       

·       Reopening the Straits of Hormuz. Iran Foreign minister has clarified that the Straits of Hormuz will be reopened with Iran supervision.  While this is not a return to the prewar situation, it should allow a restart to shipping through the Gulf of Hormuz.  This new normal will also likely involve shipping companies paying Iran a toll, which has been around 5% of the cargo value.  While this is adding a cost to Gulf crude oil/products and LNG, the premium will be a lot lower than the cost of an ongoing war.  This could mean a further gradual reduction in the risk premium in global oil/oil products/LNG and Urea fertilizers in the coming weeks.  This also reduces the risk of 2nd round inflation effects and central banks having to hike.      

·       Extended ceasefire, but comprehensive deal difficult. A comprehensive deal between the U.S. and Iran will be difficult to achieve in the coming months let alone the next two weeks.  However, President Trump will be very reluctant to restart the war, after overestimating the prospect of a quick victory.  Trump can claim that his (narrow) military objectives have been achieved (though this is only partially true) and restarting would mean unattractive options of an open-ended war; attacks on Iranian power stations prompting retaliation on Gulf infrastructure and in the worst case scenario, U.S. boots on the ground.  Trump would prefer the glory of his delayed visit to Beijing in mid-May followed by the World Cup in the U.S. in June.  Iran will negotiate hard on its 10 points, but the reality is that Trump cannot accept a number of these (e.g. U.S. troop withdrawal from the middle east).  However, Iran likely does not want to restart the war with the U.S., as their missile stockpiles and military need to rebuild.  This could mean an extended ceasefire without a comprehensive deal.  Israel has accepted the 2-week ceasefire, but will likely reserve the right to attack Iran again sometime in the future.  Iran will use the threat that an attack from the U.S. or Israel in the future will trigger closure of the Straits of Hormuz to get the U.S. to stop Israel at least for the next 6-12 months.