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Geopolitical tensions worsen, supporting safe havens

Markets are back in risk-off mode after an explosion at a hospital in Gaza shifted the calculus around President Biden’s trip to the Middle East, and raised the risk of a wider conflagration. Oil prices are rising as Iran calls for an embargo against Israel, equity futures are setting up for a softer open, and the dollar is maintaining altitude.

Flight-to-safety flows are likely to subside through the session, but Treasury yields are trading near the highest levels since 2006 after yesterday’s hotter-than-expected retail sales number raised the likelihood of more monetary tightening from the Federal Reserve. Cumulative futures-implied odds on a rate hike by January shot up to more than 60 percent after core retail sales rose 0.6 percent in September – beating expectations around 0.1 percent and pushing “nowcasting” growth models even higher.

It could be argued that markets are no longer bracing for a “hard landing” – or any landing – in the US economy, and instead expect elevated growth and inflation to force the Fed into raising rates further in 2024. We think policymakers are likely to express increasing discomfort with this view, using this week’s appearances and early December’s decision-related communications to re-anchor long-term yields near current levels.

The Canadian dollar is firmly stuck on the north side of the 1.36 mark, with yesterday’s softer inflation print helping to keep interest differentials sharply tilted against the currency. An average of the two price measures tracked most closely by the Bank of Canada – trim and median – slumped to 3.8 percent year over year in September, down from 4 percent in the prior month, and well below market expectations. Odds on a hike at next week’s meeting are down sharply as investors take a more skeptical view on the growth and inflation outlook for Canada’s incredibly-indebted economy.

In contrast, stronger-than-forecast inflation numbers are helping boost the British pound this morning. According for the Office for National Statistics, the headline consumer price index climbed 6.7 percent in September from a year earlier, defying expectations for a slowdown in matching August’s pace, and helping bolster bets on another rate increase from the Bank of England. Markets think sticky inflation pressures could lead to a final move in early 2024, but are also wary of a deeper slowdown in the economy, so the currency has generally failed to sustain gains in recent months.

After a short-lived surge higher, the yen is ignoring yesterday’s Bloomberg report suggesting that the Bank of Japan will soon raise its inflation forecast. With investors remaining unconvinced of the case for policy normalisation, and rate differentials continuing to widen against the currency amid a steep rise in US yields, we have difficulty imagining the circumstances – short of a massive risk-off move – needed to avoid a break of the 150 threshold against the dollar in the next week or two. In the longer term, an escalation in bets on US policy easing might be needed to reverse losses.

And the Chinese economy showed signs of gaining momentum in the third quarter, beating market expectations as government stimulus efforts increased. Output grew 1.3 percent in the July-September quarter, up from just 0.5 percent in the three months prior. Retail sales were 5.5 percent higher in September than in the same, zero-covid month last year and fixed-asset investment climbed 3.1 per cent in the nine months to the end of September. But property investment – at the epicentre of a historic bubbles – fell 9.1 percent in the first nine months of the year as developers failed, sales plummeted, and housing starts crumpled. We would note that a true, broad-based recovery in the Chinese economy could play an instrumental role in slowing the dollar’s gains. The euro, commodity-led emerging market currencies, and units across Asia stand to gain from a turn in the sentiment cycle – which we think is in the offing.

Still Ahead


Fed Chairman Jerome Powell is expected to follow most of his colleagues in delivering a “near peak” message on rates, but could surprise with a more hawkish tone when he addresses the Economic Club of New York. After September’s consumer and producer price indices surprised to the upside and non-farm payrolls blew the doors off, there are good fundamental reasons for thinking rates should move further into restrictive territory – however, with other soft data indicators pointing to a slowdown ahead, we think a cautious approach remains well justified. (12:00 EDT)


The British high street probably saw renewed losses in September, with consumer demand slowing as borrowing costs ratchet up. Consensus forecasts suggest retail sales contracted -0.2 percent month-over-month, down from August’s surprisingly-robust 0.4-percent gain (02:00 EDT)

Statistics Canada’s preliminary forecast for August retail sales showed a -0.3-percent drop, with weaker auto sales likely partially offset by a jump in gasoline prices – suggesting that underlying consumer spending likely moved into contractionary territory. The advance estimate for September will be closely watched, with any sign of softness likely to drive the Canadian dollar lower on the prospect of a deeper spending slowdown. (08:30 EDT)

Japanese consumer inflation might show signs of exhaustion in September, helping pour more cold water on the prospect of a sharp adjustment in the Bank of Japan’s policy settings. The year-over-year rise in headline prices is expected to drop toward 3 percent after hitting 3.2 percent in the prior month, and the core measure – which in Japan excludes fresh food – could slip to 2.7 percent from 3.1 percent in August. Imported costs – emanating from a global rise in energy prices and a domestically-driven decline in the yen – could remain elevated for months yet, but aren’t likely to justify a wholesale repudiation of the central bank’s easy-money policies. (19:30 EDT)

Will the positive vibes last?
Markets Recover As Geopolitical Risk Premia Evaporate
Sentiment swings
Israeli Strike Triggers Short-Lived Volatility Spike
Dollar Juggernaut Slows, But Remains Powerful
Higher for (even) longer