Each week I present strategist soundbites on the market, economic and geopolitical issues affecting investors. I do this to help readers quickly catch up on the big issues before they engage with clients and colleagues, or make portfolio decisions.
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Editor’s Note: Before we get into the geopolitics and market implications of the Israel-Hamas conflict, I want to express my sadness for the innocent suffering. Market analysis can appear cold and calculating. After all, it is about money. But make no mistake: war is hell.
What do Iran, Saudi Arabia, Ukraine and America have to do with the Israeli-Hamas war?
George Friedman in New York Times
Why did Hamas launch this war now, without any immediate provocation? One has to wonder if it was not on behalf of the Palestinian people but rather at the behest of Iran, an important supplier of money and arms to Hamas, to help prevent the budding normalization of relations between Saudi Arabia, Iran’s rival, and Israel. Such a deal, as it was being drawn up, would also benefit the more moderate West Bank Palestinian Authority — by delivering to it a huge infusion of cash from Saudi Arabia, as well as curbs on Israeli settlements in the West Bank and other advances to preserve a two-state solution. As a result, West Bank leaders might have earned a desperately needed boost of legitimacy from the Palestinian masses, threatening the legitimacy of Hamas.
That U.S.-Saudi-Israel deal also would have been a diplomatic earthquake that would have most likely required Netanyahu to jettison the most extreme members of his cabinet in return for forging an alliance between the Jewish state and the Sunni-led states of the Persian Gulf against Iran. Altogether, it would have been one of the biggest shifts in the tectonic plates of the region in 75 years. In the wake of this Hamas attack, that deal is now in the deep freeze, as the Saudis have had to link themselves more closely than ever with Palestinian interests, not just their own.
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If Israel is about to invade Gaza and embark on a long war, Ukraine will have to worry about competition from Tel Aviv for Patriot missiles as well as 155-millimeter artillery shells and other basic armaments that Ukraine desperately needs more of and Israel surely will, too.
Vladimir Putin has noticed. Last Thursday in the Black Sea resort of Sochi, he said that Ukraine was being propped up “thanks to multibillion donations that come each month.” He added, “Just imagine the aid stops tomorrow.” Ukraine “will live for only a week when they run out of ammo.”
Energy prices rise on potential implications
Vandana Hari, CEO of Vanda Insights
We may see a knee-jerk surge in crude prices when markets open on Monday. There will be some risk premium factored in as a default, until the market is satisfied that the event is not setting off a chain reaction and Mideast oil and gas supplies won’t be affected.
Iman Nasseri, Middle East managing director of energy consultancy Facts Global Energy
The impact on the oil price will be limited unless we see the ‘war’ between the two sides expand quickly to a regional war where the U.S. and Iran and other supporters of the parties get directly involved.
Why did yields just spike? Hint: it’s not only about inflation
Solita Marcelli, Chief Investment Officer Americas, UBS Global Wealth Management
The higher-for-longer fed funds rate expectation does not explain the entirety of the move. Other factors such as a rise in oil prices, quantitative tightening (QT), and a potential US credit rating downgrade due to government shutdown fears / dysfunction could all be playing a role. And particularly notable over the past few weeks has been the enormous imbalance of supply and demand in the market. The Treasury department has to simultaneously fund a deficit and refinance existing debt, resulting in USD 800bn of coupon issuance by year-end. The Fed is no longer buying these bonds with QT ongoing in the background. For the first time in decades, the US bond market seems to be waking up to this dynamic. As a result, the term premium—the compensation that investors demand due to the uncertainty about the outlook for longer-term interest rates—has, by some estimates, increased well over 50bps just in the past month.
The Canadian consumer is starting to “buckle”
Jonathan LaBerge, CFA, BCA Research
The Canadian consumer is starting to buckle under the weight of high interest rates.
– Canada’s Q2 growth slowdown was driven by consumer spending.
– Mounting debt service is already impacting Canadian consumers and will rise further even without any additional rate hikes from the Bank of Canada.
– Significant further rate hikes are unlikely, as recent trends in Canadian inflation point more toward a stalling disinflationary trend rather than a true reacceleration.
– Fundamental support for Canadian bank stocks may be rapidly eroding due to mounting loan loss provisioning.
Why Canadians should favor bonds over GICs
Adam Ditkofsky, Vice President, Senior Portfolio Manager at CIBC Asset Management
Bonds are now paying eyebrow raising yields, with government bonds ranging from 4.0% to 5.0%, and investment grade corporate bonds paying north of 6.0%. We would even argue that bonds make more sense than GICs at these levels, as not only are investors earning similar yields, but bonds eliminate near term reinvestment risks, benefit from favourable tax treatment (for bonds trading below par) and provide portfolios with downside protection in risk-off periods. So, for investors who have shied away from bonds over the past 3 years, it may make sense to revisit them seriously, because at this juncture the move we’re seeing in rates is having a noticeable impact on risk markets.
A potential goldilocks scenario for the US
David Kelly, Chief Global Strategist at J.P. Morgan Asset Management
The strong payroll gain confirms other measures of a tight labor market including a 690,000 rebound in job openings at the end of August to a lofty level of 9.61 million and very low unemployment claims in recent months. However, the number of people quitting jobs has now returned to normal levels, indicating that workers do not perceive that they have extraordinary bargaining power. This is also evident in the steady downtrend in year-over-year wage growth since March 2022 despite an unemployment rate that has remained below 4% since December 2021. Moreover, despite widespread media coverage of some high profile strikes, the number of major strikes this year, at 19 through August, is close to the 23 reported for all of last year and far below the 200+ annual strikes seen in the late 1960s and 1970s.
All of this suggests that in a post-pandemic labor market, an unemployment rate below 4% may still be compatible with moderate growth in wages and the Fed’s 2% inflation target. If this is the case, then both high-quality fixed income and U.S. equities should benefit from an economy that can maintain economic strength without producing inflationary heat.