Tensions escalating in Middle East

In focus today

In the US, ADP private sector employment growth will provide some early hints of what to expect from Friday's NFP release - consensus expects a modest rebound from August.

In the euro area, we receive the unemployment rate for August. Recently, we have seen the first signs of a cooling in the euro area labour market, but overall, it remains very strong.

In Poland, NBP will announce their rate decision, where we and markets expect the policy rate to stay unchanged at 5.75%.  

Economic and market news

What happened overnight

Overnight, the vice-presidential debate between Republican J.D. Vance and Democrat Tim Walz took place. The candidates discussed issues like U.S. foreign policy, inflation, and abortion. The debate remained cordial, with each focusing their attacks on the opposing presidential candidate, as traditionally has been the case in vice-presidential debates. Vance criticized Vice President Kamala Harris on border security, while Walz targeted former President Donald Trump over abortion rights. Overall, the debate was fairly civil compared to last month's presidential faceoff, and did not change prediction markets much, which still show Harris having a slight edge.

What happened yesterday

In the US, Tuesday's data provided mixed signals, but overall supported our notion that the economy remains on a solid footing. The September ISM Manufacturing index was unchanged at 47.2, with weaker sub-indices for prices and employment but stronger new orders. The inventories sub-index also declined, and a combination of stronger order books and falling inventories is often a positive signal for demand. August's JOLTs job openings rebounded after ticking down in July, and past month's data was revised up slightly. Hiring continued to slow, though the number of involuntary layoffs also declined. Thus, the reading suggested that labour markets conditions are not weakening sharply.  

In the euro area, as expected September HICP inflation declined to 1.8% y/y, while the core measure was stickier, dropping to 2.7% y/y from 2.8% in August. The headline decline was mainly driven by energy inflation, due to base effects and a monthly price decline in energy prices. Core inflation was driven by very low goods inflation at 0.4% y/y and high services inflation at 4.0% y/y in September. The ECB is still focused on too high services inflation, which printed 3.97% y/y in September, which remains a key upside risk for the inflation outlook. That said, the most recent momentum shows some easing signs, and all in all the September print was supportive for an October rate cut by the ECB.

In Sweden, the Riksbank Minutes for September indicated that the discussion between 25bp vs 50bp was absent for most members and no one seemed to prefer moving in 50bp steps. For a more detailed overview, please see Riksbank - September 2024 Minutes - No member arguing for a 50bp cut, 1 October.

In Middle East, tensions are far from abating. Israel commenced a ground offensive in Lebanon after two weeks of airstrikes against Hezbollah, including killing its former leader, Nasrallah. Iran retaliated by launching a missile attack on Israel, with drones and ballistic missiles. The market reaction to Iran's attack was quite limited, and oil prices even reversed some of the earlier gains (at some point up about 4% during yesterday's session). This in line with our assessment that the threshold for market reaction to a such protracted conflict is very high.

Israel and the US vowed to retaliate against Tehran, with Israeli prime minister Netanyahu warning "Iran made a big mistake tonight - and it will pay for it". In our view, the best-case scenario is something like what happened in April. Then Iran launched missiles that were completely intercepted, and Israel responded with a missile attack on Iran that also caused very limited damage.

Equities: Global equities were lower yesterday despite solid increases in Japan. The US session was beset with several sets of information that could obscure the distinction between noise and genuine drivers. However, it is worth examining the sector rotation, where energy emerged as the best-performing sector following a rise in oil prices due to escalating tensions in the Middle East. Secondly, technology was down significantly, while industrials continued to perform well. Hence, this downturn was not solely due to poor macroeconomic data, but also significantly influenced by sector-specific stories, with high-flying tech companies like Apple and Nvidia being particularly affected. This morning, Chinese stocks have risen sharply in Hong Kong, while Japanese stocks are down by 2%, highlighting the diverse and substantial factors currently affecting financial markets. In the US yesterday, the Dow closed down 0.4%, the S&P 500 fell by 0.9%, the Nasdaq declined by 1.5%, and the Russell 2000 increased by 1.5%. European futures are higher this morning while US once are lower.

FI: European yields declined from the long end yesterday with the 30y point down almost 10bp to 2.33%. The benchmark 10y German bund is now flirting with the 2% level after the 8bp rally to 2.03% yesterday. While the move can somewhat be explained with the European inflation figures released, supporting the case for an October rate cut, the bullish flattening of the curve may be explained if markets expressing concern above the service sector as well (and in turn the services growth sector). Markets are now pricing 23bp for October and another 32bp for December. Yesterday, ECB's Rehn said that the inflation slowing meant that there was more grounds to be covered in October on a potential rate cut. Tomorrow, we look forward to Schnabel speaking at 18:45 CET. We also have a string of central bank speakers today (Lane, de Guindos, Bowman etc).

FX: Iran's missile strike on Israel increased safe-haven demand, boosting the USD and pushing oil and gold prices higher. The move faded somewhat towards the end of the session as reported damages were seemingly limited. The setback to risk hurt the SEK whereas the NOK found support in rising oil prices, although we emphasize that rising oil prices need not be interpreted as a buy signal for the NOK. Yesterday we went short AUD/USD as we see the soft landing scenario being priced to perfection and subject to two-sided US growth risks.