All eyes on safe havens, after mega payrolls report

The news at the weekend about Hamas attacks on Israel have shocked the global investing community, as another geopolitical risk comes into focus. Israel has now declared war on Hamas, which is likely to have an impact on financial markets, however, the extent of the impact could depend on how events play out over the next few days.

Whenever geopolitical risks arise, especially ones with high levels of international attention such as this, we tend to see a flow of money into haven assets. This weekend’s events highlight the benefit of owning some gold and dollars in your portfolio, both of which tend to rise when there are periods of geopolitical conflict. At the time of writing, most financial markets are closed, however, the FX market is open, and we have seen a bout of dollar strength in Asian hours. We expect to see this continue as we progress through Monday, with gold, the dollar, the yen, and the Swiss franc all rallying as they are the traditional haven assets. Some equity markets in the Middle East are tradable on Sundays, and these markets suffered heavy losses, including a 1.57% decline for the Saudi Arabian index, a 6.47% decline for the Tel Aviv 35 and a 1.56% decline for the Kuwait Main Index. We would expect to see European stocks sell off at the start of this week, however, until we know how protracted the war between Israel and Hamas will be, the selloff could be mild. We will also be watching US Treasuries closely to see if they attract haven flows even after the US’s turbo charged payrolls report for September, and we will be watching the impact on the oil price.

Oil and the Middle East

Energy markets will be in focus at the start of this week. While Israel and Palestine are not oil producers, the ripple effects of this weekend’s effects could impact oil prices, especially with oil supply tight since Saudi Arabia and Russia’s supply cuts that will last until the end of this year. Iran, who has been accused of supporting Hamas and celebrating their actions against Israel, had been boosting oil production in recent months, which was loosening the overall supply of oil in the global market. While this helped to neutralise some of the impact of the Opec + supply cuts, if relations between Iran and the US, which are bad at the best of times, deteriorate further on the back of Iranian support for Hamas, then we could see the oil price rise in the medium term. The Brent crude price was trading around $85 at Friday’s close, down $9 on the week, and down $11 from a month ago. Will the impact of further geopolitical risks cause the oil price to make another attempt above $90 per barrel? There is no way of knowing and using history as a guide may not be too useful, as we have no way of knowing right now how the conflict will play out. The last round of conflict between Israel and Palestine started on the 10th of May 2021, until a ceasefire on the 21st of May 2021. Back then the price of Brent crude dropped $2 per barrel over the course of the conflict. However, that feels like a different era, back when the world was emerging from Covid lockdowns, there was no Ukraine war and Opec had not embarked on supply cuts. Thus, the decline in the oil price in 2021, may not be repeated in 2023, instead the latest conflict in the Middle East could be associated with higher oil prices.

Geopolitics and bonds

With inflation and economic data potentially taking a step back from the spotlight, as geopolitical risk takes centre stage, it will be interesting to watch where fixed income goes next. Will short-dated Treasuries act as safe havens, even if a spike in the oil price has negative inflationary effects for the West? We will have to wait until Tuesday to see the full effect of this geopolitical crisis on the US Treasury market since it is closed on Monday for a public holiday in the US.

Will China step up to a global peace-making role?

Some are also concerned that the timing of the events in Israel coincides with a period of political chaos in Washington, with another debt ceiling debate looming next month, and the ousting of Republican House Speaker Kevin McCarthy by his own party, all adding to political upheaval in the US. This comes at the same time as the world would usually look to the US for geopolitical leadership during these events.

Whether or not this becomes a major turning point in the Israel- Palestine conflict will depend on how long it last and if other countries in the region get dragged into it. We will also be watching to see Saudi Arabia’s reaction, they have already called for a de-escalation of the crisis, which threatens to de-rail talks between Saudi Arabia and Israel along with the US, to boost the “normalisation” in relations between Saudi and Israel. This conflict could also expose Saudi Arabia and China as major power brokers in the region after Saudi Arabia and Iran announced a restoration of relations, in a deal brokered by China earlier this year. Thus, in signs that the US’s influence in the region could be waning and it will be interesting to see if China and Saudi Arabia urge Iran to use some diplomacy and restraint when it comes to supporting Palestinian attacks on Israel. Thus, it could be Saudi and China who calm the situation down and help to assuage risk aversion in the coming days, and not the US.

US CPI in focus

The other focus this week will be economic data. Payrolls rose by 336k in September, the market had expected an increase of 170k, the August figure was also revised up to 227k from 187k. The unemployment rate rose a notch to 3.8%, and the pace of average wage growth declined to a 0.2% monthly rate and a 4.2% annual rate from a 4.3% annual rate in August. Thus, last month’s payrolls report had something for everyone, however, it still suggests that the US economy is strong enough to continue to hire staff. This week we get the CPI report for September, and the market is also expecting a modest decline in the pace of price growth last month. Headline CPI is expected to decline a notch to 3.6% from 3.7% in August, while core price growth is expected to fall to 4.1% from 4.3%.

The strong payrolls report and the potential for an elevated level of core inflation, could support the Fed’s higher for longer mantra. Interestingly, US stocks staged a decent rally on Friday, with both the S&P 500 and the Nasdaq rising by more than 1%. The S&P 500 had its biggest intra-day comeback since March. This could be driven by 1, a recovery rally after a weak September and 2, growing signs that the earnings recession for US corporates could be over if US firms are still willing to hire. We could also see good economic news translate into positive market moves, as it highlights economic strength in the US. The move in US stocks was encouraging for the bulls, as it happened at the same time as bond yields rose and the 10-year US Treasury yield jumped back above 4.8%. When the US bond market reopens on Tuesday, we expect limited movement until we get the key US CPI report on Wednesday, which highlights the importance of this week’s economic data for the future direction of stocks and bonds.