THE summer lull is well and truly over. War, cracks in the bond market and a flood of key data announcements mean there’s plenty for investors to focus on this week.
Here we go again
The outbreak of hostilities in Israel – 700 dead, retaliatory bombing of Gaza, manoeuvres on the Lebanese border – is wearyingly familiar. As ever, the market impact has been felt most immediately and obviously in the oil price, which has jumped back to nearly $90 after easing recently on growth fears.
Israel is not an oil producer but its frosty relations with both Iran and Saudi Arabia mean it is a key influence in the oil market. Iran has been a major supplier of crude recently thanks to weak enforcement of sanctions. Tighter policing of those is likely now thanks to the country’s support of Hamas, which led the weekend’s attacks across the border with the Palestinian enclave of Gaza. And Saudi Arabia’s willingness to keep the market supplied may become less reliable as regional tensions increase.
Oil matters on a number of fronts. As a key input for many companies, a rising price raises the chance of recession, already top of the list of worries for investors as interest rates start to bite. It is also a key driver of inflation, which in turn feeds through into the higher for longer interest rate story.
For older investors, there’s a sense of déjà vu. The Yom Kippur war in 1973, and the oil embargo it triggered, combined with inflation and an economic slowdown to produce the sapping stagflation which wreaked such havoc in financial markets in the 1970s. That vicious cocktail of factors played out throughout the decade until markets finally bottomed in 1982 after Paul Volcker, Fed chair at the time, started to win his battle with inflation.
Bond yields surge
The current war on inflation is playing itself out in markets in the form of a destabilising surge in bond yields. The 10-year Treasury is yielding 4.9% and the 30-year is even higher at more than 5%, both standing at levels not seen since before the financial crisis.
The immediate question is whether the rise in borrowing costs makes a further hike in interest rates more or less likely in November. One argument is that the markets are doing the Fed’s work for it by tightening financial conditions. Futures markets now assign just a 30% possibility of another quarter point rate hike in the US. Two weeks ago, it was 50%.
Meanwhile on the data front
Apart from these two market stories, there is also plenty to watch with economic announcements due this week on growth and inflation around the world. Top of the agenda is US inflation, which is forecast to have moderated very slightly to 3.6% this month, much lower than its peak but still well above the Fed’s 2% target. That argues for rates peaking at or close to the current level but also falling back much less slowly than hoped over the next couple of years.
Here in the UK, growth is in the spotlight, with hopes that GDP in August returned to modest growth after July’s wet weather and strike affected 0.5% fall. And, finally, China has both inflation and trade data this week. The risk of deflation in China seems to be fading but the trade numbers are likely to be disappointing, with exports and imports both down. The catalyst for a recovery in China’s weak equity market still looks to be some way off.
