Risk sentiment remained shaky over the past week as markets digested a mix of renewed geopolitical worries, mixed data on inflation and cautious signals from the central bankers. The conflict between Israel and Hamas has quickly escalated into the worst bloodbath in 50 years on both sides. Hamas’s attacks are estimated to have caused 1300 casualties, most of which civilian, while Israel has begun a massive counteroffensive towards Gaza in response. Possible involvement of the Iran-backed Hezbollah remains a key worry, although many of the surrounding Arab nations, including Qatar and Egypt, have so far pushed to avoid further escalation. As both Israel and Iran are small natural gas exporters, and the production of the former has already been affected, European natural gas prices rose by around 40% this week. Oil markets have remained calmer, dampened by cooling demand and spare production capacity especially in Saudi Arabia. Read our early take on the outlook from Monday: Geopolitical radar – Extra edition: Fauda – what to expect from chaos in Israel? 9 October.
On the data front, US September CPI surprised to the upside for the second month in a row. Headline CPI rose by 0.4% m/m (consensus 0.3%), while core CPI was better in line with expectations at 0.3% m/m (consensus 0.3%). Shelter inflation (+0.65% m/m; Aug +0.29%) accelerated against expectations, even though more timely rental price indices still point towards moderating inflation. Health care prices, which are distorted by lagged estimation of health insurance premiums, contributed to the upside surprise as well. Excluding the two categories, core services inflation cooled in m/m terms, which is a positive signal of moderating underlying inflation for the Fed. We still believe rate hikes are already over in the US, which remains the base case for the markets as well. We discussed the mixed data in more detail in our monthly Global Inflation Watch, 13 October.
While equity and credit markets remained relatively stable, longer-dated US yields rose towards the end of the week and broad USD appreciated. Besides the CPI print, weak demand on 3y, 10y and 30y UST auctions played a role, as persistent budget deficits seem to remain a key worry for markets even amid the uncertain economic outlook. In any case, central bankers have sounded increasingly cautious about hiking rates further in an environment where financial conditions have tightened markedly since summer. September meeting minutes from both the ECB and the Fed also flagged growing worries about the risk of overtightening monetary policy.
Next week, the focus will turn to economic data. US retail sales are expected to signal weakening consumer demand after early credit card data and leading services PMI components fell in September. In Europe, German October ZEW index will provide hints on the latest investor sentiment amid higher uncertainty, and final September HICP data will give more detailed insight into inflation drivers. In UK, focus will be on both labour market and inflation data. The latest KPMG and REC report on jobs pointed towards cooling wage inflation, while markets will keep a close eye on if the August downtick in price inflation was just a one-off. In China, Q3 GDP is expected to come out around 1.0% q/q, which would pave way for the government to meet its growth target of 5%.
