Financial Markets React to Israel/Hamas Conflict: Analysis and Outlook
Comment by Vladimir Oleinikov, Senior Quantitative Analyst at Generali Investments
- Federal Reserve Chair Jerome Powell confirmed no hikes in November.•US retail sales came out really strong (at 0.6% mom vs expected 0.1%), while US IP printed at 0.3% (vs 0%).
- EA ZEW release was somewhat better than expected, confirming the readings from previous sentiment indicators. Disinflation is on its track, as seen in Germany's PPI data.
- Long-dated government bonds sold off driven both by higher real yields and increasing inflation expectations. US yields have reached the highest level since 2007. Equities have fallen across the board, while oil prices increased by 2% only.
What's the key events ?
- The release of EA flash Consumer Confidence (Mon) gives an indication whether the turn in confidence also reaches consumers.
- Global flash PMIs will be likewise the key highlight this week (Tue).
- The 1st release of US Q3 GDP is to be seen on Thursday, with strong acceleration expected.
- Durable goods (Thu) are likely to make a headline. Keep in mind, the big order received by Boeing.
- The ECB will be in focus on Thursday. No hikes are expected.
- Core PCE inflation (Fr) is expected to reaccelerate a bit in MoM terms, while decreasing in YoY terms.
- Univ. of Michigan sentiment (Fri) is expected to pick up a bit.
A Chart Speaks a Thousand Words
Israel/Hamas conflict: in our base scenario, market reaction likely contained
At a time when the global economy is shaky and the strength of the US is waning, Hamas has launched its surprise attack on Israel. Since then, the reaction in major stock markets has been rather muted: US, European and EM equities are down around 2.0%, well below the average drawdown of 15% seen after the start of the Russia-Ukraine conflict in February 2022, while stock markets have already receded by ca. 9% since their recent peak in late July. Whereas there is a risk of a major regional war, we see a higher probability of a contained war and believe that equity markets will continue to be driven by global factors. In the short term, we expect growth to come to a halt in the EA and to slow significantly in the US. Other negative factors for equities are high yields, rich US valuations and weak M2 momentum. Accordingly, we maintain our underweight in equities, expecting a temporary moderate increase in equity volatility. We acknowledge the risk of a possible escalation in the Israeli conflict through direct Iranian involvement (not our base case). In this case, oil prices would spike (risk premia, US sanctions against Iran, potential disruptions across the Strait of Hormuz) and the global economy would experience another strong stagflationary shock. In this case the equity markets would likely see drawdowns of around 15-20%, with the US outperforming. In the base scenario, the continued near-term market fall would increase the equity market appeal through low EU valuations and deteriorated positioning.
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