Treasury Yields Decline While Equities Gain, Investors to Monitor Potential for Broadening Middle East Conflict
Last Week Review
The two-year Treasury yield declined 0.03% and the 10-year Treasury yield fell 0.19%, marking a partial reversal from significant upward moves the prior weeks. Global equities gained 0.7%, with non-U.S. equity gains supporting returns. Real assets gained as natural resources rose on a 5% rise in oil prices following the conflict in Israel.
Israel-Hamas Conflict Heightens Global Political Challenges
Investors contended with newly introduced global political risk after Hamas’ attack on Israel. Last week, Israel began to plan its response, likely a ground invasion into Gaza. Despite the considerable humanitarian toll, we expect financial market risks from the conflict to be contained unless the war broadens — specifically to involve Iran, where about 20% of global oil flows through the Strait of Hormuz. So far, there have been little evidence of Iranian involvement nor interest from Israel, the U.S. and others in a broader Middle East conflict.
Services Drive U.S. Inflation Above Expectations
U.S. inflation in September rose more than expected to 0.4% month-over-month and 3.7% year-over-year, based on the Consumer Price Index released last week. Core inflation, which excludes more volatile food and energy prices, aligned with expectations at 0.3% month-over-month and 4.1% year-over-year. Core goods declined 0.4% month-over-month and core services accelerated to 0.6%. Core services excluding housing — the “super core” measure highlighted by the Fed — also jumped 0.6% month-over-month. The slightly stronger than expected inflation data disappointed equity investors looking for stronger signs of disinflation. However, while the data was strong enough to push up Treasury yields across the curve, the we think the market believes the Federal Reserve is done tightening. Comments from several Fed policy officials last week reinforced this narrative while the we think the September Fed meeting minutes offered little new major details that would alter investors’ opinion.
Big Banks Exceed Third Quarter Earnings Expectations
Last Friday, results from JPMorgan (JPM), Wells Fargo (WFC) and Citigroup ( C ) were better than expected, supporting outperformance from the banks relative to the U.S. equity market. JPMorgan cited healthy U.S. consumer activity with help from persistently tight labor markets. Aggregate earnings of companies in the S&P 500 Index are expected to grow 0.3% year-over-year on a 1.8% rise in revenue.
This Week Preview
Fears of Shock to Oil Supply if Israel-Hamas Conflict Broadens
A broader Israel-Hamas conflict potentially may shock supply in already tight oil markets, driving up prices at a time when investors question the durability of global economic growth. We expect investors to continue to evaluate this risk, with the extent of participation by Hezbollah likely to be a key watchpoint. The U.S. has come out with support for Israel — and has an interest in containment — but direct support has been restricted by the vacancy of a speaker in the U.S. House of Representatives. Two contenders in last week’s race for the role failed to garner enough votes, so we expect the search for a leader to continue this week.
China’s Struggle to Recover on Watch
Last week, China equities benefited from consideration by Beijing to take additional stimulus action. While there have been signs of stabilization, economic activity remains lackluster with several pressure points. Just last week, property developer Country Garden warned of default. We think investors will respond to any new stimulus while analyzing the situation on the ground in China, with fixed asset investments, industrial production and retail sales data scheduled for release this week.
Bank of America, Procter & Gamble and Tesla to Report Third Quarter Earnings
Bank of America (BAC) and Goldman Sachs (GS) third-quarter earnings are set for Tuesday. Procter & Gamble (PG), Tesla (TSLA), Taiwan Semiconductor (TSMC) and Schlumberger (SLB) are scheduled to report thereafter.
Source: Bloomberg for data, news developments and schedule of economic releases. Data as of October 15, 2023.
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