War In Israel Adds To Uncertainty

The weekend attacks on Israel affected markets’ expectations for the path of interest rates.

Monday, October 9, 2023

· The Americas: The weekend attacks on Israel affected markets’ expectations for the path of interest rates. As of this morning, the probability of an increase in the fed funds target rate next month fell below 20% as investors anticipate the conflict will put a brake on the global economy this quarter. Despite a strong headline payroll report on Friday, wage pressures appeared to weaken, adding support to markets’ view that the Federal Reserve (Fed) will keep the target rate unchanged when the FOMC meets in a few weeks.

· Europe: War in Israel will likely put upward pressure on oil prices and higher oil prices will put European investors in a bind. Growth is tepid in the region and if investors have to deal with rising inflation pressures, we should expect choppy markets in Europe until the geopolitical risks simmer.

· Asia-Pacific: India’s Services PMI rose to 61 in September, an increase of 0.9 from the previous month. The growth was primarily driven by an increase in consumer demand and an increase in overall investment in new businesses. Although domestic demand remained relatively strong, foreign demand, most notably from Europe, North America and some parts of Asia increased as well. Investors should know that the service sector accounts for over 50% of India’s economy and the sector continues to grow for the time being. India is one of the few bright spots in the global economy.

Stocks Open Lower on Middle East Conflict

· At the open: U.S. equities open lower as West Texas Intermediate crude oil jumped 4% amid this weekend’s Middle East conflict.

· Bloomberg reported that 80% of respondents in the Bloomberg Markets Live Pulse survey said they expect U.S. retailers and consumer-related companies to “warn about profit and revenue trends” during the upcoming earnings season.

· European stocks are lower through midday trading on the Mideast conflict and as German regional elections showed all three parties in the federal coalition government are on track to lose support amid the nation’s economic challenges.

· Asian markets ended mixed as global investors shun the Chinese market, selling $11 billion of Chinese A-shares between July and September, despite improving economic data.

· Friday’s Recap: Markets rebounded Friday as all major sectors ended in the green with the exception of consumer staples. After an initial selloff on the strong jobs report Friday morning, stocks reversed solidly higher as the smaller-than-expected increase in wages helped limit the magnitude of the sell-off in Treasuries. The S&P 500 Index inched higher last week as the communication services and information technology sectors continued their leadership status for 2023.

Oil Prices Climb Amid Israeli/Hamas Conflict—Which So Far Remains Constrained

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· The jump in crude oil prices remained constrained this morning as the conflict, thus far, appears to be focused on the immediate region of the Hamas stronghold, which is not oil producing.

· For the energy markets, natural gas prices climbed higher as Chevron was told by Israel’s Ministry of Energy to shut down a facility close to the Gaza Strip.

Oil prices, however, will move dramatically higher if it appears the diplomatic effort is failing.

· Crude oil prices are on hyper-alert for any indication the conflict is poised to spread into the oil producing regions in the Middle East, particularly with regard to Iran. Although initial reports suggested that Iran supported and helped with logistics of the attack on Israel, Iran denies having a role in yesterday’s assault. The U.S. is involved in a broad reaching diplomatic effort to keep the conflict contained.

· Oil prices, however, will move dramatically higher if it appears the diplomatic effort is failing.

· There are reports the U.S. will release oil from the Strategic Petroleum Reserve (SPR) if necessary. This is despite the fact that reserves in the SPR are lower by 43% since the start of the Ukraine/Russia conflict. Replenishing the SPR has been interrupted by continuing delays.

· Crude oil prices had been oversold coming into this week, but with a headline driven market filled with rumor and inaccurate reporting, oil prices can be subject to significant swings. Any chatter that Israel, now seemingly focused on shutting down Hamas’s operations, is preparing to strike beyond the immediate conflict, will escalate the push in prices.

Potential Equity Market Implications of War in Israel

· The first place markets will see the impact of fighting in Israel will undoubtedly be the increased risk premium embedded in oil prices, which would be expected to support the energy sector as markets assess the likelihood that Iran is brought into the conflict. LPL Research maintains its overweight recommendation on the energy sector.

· The potential impact on the broader equity markets is difficult to predict because the risk of a wider conflict involving Iran or other enemies of Israel in the region is difficult to assess. Still, that risk pushes the VIX higher, sends stocks potentially lower (as it is doing this morning at the open), and perhaps shifts market leadership more toward defensives (utilities, gold, Treasuries, etc.).

Stocks have historically held up well during geopolitical shocks... going back decades.

· But if fighting remains contained to Israel and Gaza, the market impact will likely be very limited as oil prices may not sustain gains.

· Stocks have historically held up well during geopolitical shocks, including wars and other military conflicts going back decades. Stocks tend to be higher one- and three-months after these events.

· Defense spending will likely increase if this news provides a catalyst for Congress to figure out how to govern in short order. Defense stocks should get a bid.

· The Strategic and Tactical Asset Allocation Committee (STAAC) maintains its neutral stance on equities but will continue to watch the Middle East closely to determine potential impact on energy and the broader markets.

Higher For Longer—Updating Our Treasury Forecast

· U.S. Treasury yields have seemingly been moving in one direction lately (higher), with the 30-year Treasury yield temporarily breaching 5% for the first time since 2007.

· The move higher in yields (lower in price) has been unrelenting, with intermediate and longer-term Treasury yields bearing the brunt of the move.

· There are several reasons we’re seeing higher yields, but rates are moving higher alongside a U.S. economy that has continued to outperform expectations, pushing recession expectations out further, and by the unwinding of rate cut expectations to be more in line with the Fed’s “higher for longer” regime.

· And with the economic data continuing to show a more resilient economy than originally expected, we think Treasury yields are likely going to stay higher for longer as well.

· As such, we now project the 10-year Treasury yield will end the year between 4.25% and 4.75% (previously 3.25% and 3.75%).

LPL Research

(The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.)