Week ahead: Geopolitical risks step up as commodities surge

Risky assets ended last week in the red, after news that Israel was preparing for a land invasion into Gaza sent commodity prices soaring. After last weekend’s attacks in Israel, the initial flight to safety petered out, however, fighting has since intensified between Israel and Islamic fighters along the boarder with Lebanon, which is increasing fears that the Israel/ Palestine conflict will spread across the region. As we mentioned last week, war is inflationary, and war in the Middle East is particularly inflationary due to the importance of oil production in the region. Israel, in a highly unusual move, evacuated the entire town of Sderot, close to the Gaza boarder on Sunday. Added to this, Israel has also accused Iran of supporting Lebanese militant attacks, and there are signs that Iran is increasing the presence of its Revolutionary Guard on the boarder with Syria. These dramatic developments over the weekend could see the Brent crude oil price rise above $90 per barrel, after it rose 5% on Friday.

UK gas prices worth watching

Commodities are in focus as we start a new week. Not only is the oil price surging, which may continue if we continue to see wider tensions in the Middle East spill over, but European gas prices jumped 50% last week. The rise in gas prices is clouding the inflationary outlook for the UK and other parts of Europe, as cooler weather combined with geopolitical risks and strikes at an Australian LNG plant all add to supply side concerns as we move into the winter months in the Northern hemisphere.  The UK gas price is nearly 139p a therm, this is up from 85p a therm last week. While this is a massive jump, it may be too soon to panic right now. For example, last December the gas price peaked at more than 375p per therm, so we are still nowhere near these levels, also storage capacity is well stocked, which could also limit the impact of the recent price jump.

 Commodity supply risks heat up as we head into winter

Even so, the risks facing the commodity market are multiple and complex. For example, even though the International Energy Agency said that it is seeing the early stages of demand destruction for oil, it still forecasts oil demand growing by 2.3mn b/d in 2023, followed by a 0.9mn b/d increase in 2024. Added to this, the oil market remains in a deficit, i.e., oil supply is below demand, and this is not set to reverse until the first half of next year. Oil shipments from Saudi Arabia into the US declined to a mere 67,000 barrels last week, the third lowest level in more than 20 years, according to Bloomberg. This comes as the Saudis remain committed to oil production cuts. With the current geopolitical issues, we do not foresee shipments of oil from Saudi Arabia to the US or other parts of the Western world picking up substantially while the conflict between Israel and Palestine remains fraught. These are the times when we must all hope that the world’s top diplomats can work overtime to urge restraint from both sides and find a solution to reduce tensions in the region.

US growth rate expected to surge above China’s in Q3

Elsewhere, the markets will be focussed on economic data next week including China Q3 GDP, retail sales and industrial production, along with the UK’s labour market report for September and last month’s inflation report. The market is looking for China’s GDP to expand by 1% last quarter, up from the 0.8% rate in Q2. The annual rate is expected to fall to 4.4% from 6.3%, which, if correct, is a clear sign that the pace of growth in China post the pandemic has fallen sharply, and the world needs to get used to that. What is more astonishing, is that multiple people have been looking for a US slowdown this year that shows no signs of materialising. The Atlanta Fed GDPNow forecast suggests that US growth will expand by a whopping 5.1% for Q3, that is up from 4.9% last week. With the majority of major data releases already included in the estimate, we can expect a bumper GDP report from the US in the penultimate quarter of the year. The US economy is showing no signs of slowing, instead it is showing signs of gaining momentum and heating up as we move into the final months of the year. Also, with China faltering under the weight of a struggling property sector, the US rate of growth is expected to outpace China, which could be good for risk sentiment, especially with the geopolitical risks that have materialised in recent weeks.

The Fed could strike a dovish tone

While a 5%+ growth rate could increase expectations that the Federal Reserve will hike interest rates in the future, the Wall Street Journal’s Fed whisperer Nick Timiraos, wrote last week that the rise in long term yields in the US in recent weeks is likely to extend the Fed’s pause. Expectations for a rate hike to 5.5-5.75% by the end of this year have fallen to 28% from 37% a week ago. Some Fed speakers have also mentioned that the rise in long term yields, 10-year yields have risen by 80 basis points in the last 3 months, has done some of the Fed’s work for them on the tightening side. The rise in the term premium – the extra yield necessary to attract investors to buy long term debt – has also risen, with some Fed officials blaming this on the rise in the US deficit. A permanently higher term premium could see the end of the Fed’s hiking cycle, but it could also hurt the US economy down the line and weigh on risky assets. Thus, even if the GDP rate in the US is turbo charged for Q3, unless Washington gets a handle on the expected size of future deficits, then it is hard to see how the US can keep up this pace of growth.

UK CPI to determine what BOE does next

The UK’s economy is also in focus this week, with both labour market data and CPI for September. The market is expecting a 195k drop in jobs for August, with the unemployment rate remaining steady at 4.3%. The 3 months on month rate of average wage growth is expected to moderate slightly inc. bonus to 8.3% from 8.5%. Any weakness in the average wage data could trigger a decline in the pound, but also lower expectations for further rate hikes from the BOE. The outgoing deputy at the BOE, Sir John Cunliffe, has said that he expects UK interest rates to remain higher for longer, but ultimately the direction of rates will depend on the CPI data for September, that is released on Wednesday. The market is expecting a decline in the headline rate to 6.5% YoY from 6.7% in August, with the core rate also expected to fall to 6% from 6.2% YoY. Elsewhere, it’s also worth watching UK Producer price data for September to see what the pressure is like at the start of the pipeline, and whether or not the rise in commodity prices has impacted PPI, which tends to be a good indicator of future CPI. Any uptick in PPI may suggest that inflation pressure is rising in the UK.

Earnings deliver good news, but can it last?

Elsewhere, earnings are also in focus this week, with the rest of the US banks reporting, along with Netflix and Tesla. The stock market is dealing with a lot of conflicting information right now. Geopolitical risk vs. a stronger US Q3 growth rate, which could provide a boost to Q4. Added to this, although the major US banks that reported at the end of last week continued to point out the risks to their outlook, JP Morgan, Wells Fargo, and Citigroup reported a joint $22bn in profits in Q3 on the back of higher net interest income, which helped the S&P 500’s financial sector to post a gain on Friday, even though the broader index declined. The S&P 500 is expected to post a 0.4% gain in YoY earnings growth for Q3, which is the first increase since Q3 2022. If this can boost broader market sentiment, which remains shaky, we will need to see some positive Q4 outlooks, which may not be possible with the double whammy of geopolitical risk and rising long end bond yields.