The attack by Hamas on Israel on October 7th, as well as the terrible loss of civilian lives that followed Israel’s retaliation, has shocked the world.

Across the Middle East, fear has spread over the possible outbreak of a broader regional war, disrupting progress on diplomatic relations between Israel, the Saudis and other neighbours.

The prospect of the conflict spreading across the Middle East via militant groups like Hezbollah in Lebanon, and other regional militias in Yemen and Syria opening multiple fronts against Israel, might have been expected to unnerve global equity markets. However, investors’ assets have made no significant migration to financial havens as yet. While the Gold price rose over 7%, perversely perhaps, the price of oil fell by over 5% during the month, implying confidence (among investors at least) that the conflict won’t accelerate sufficiently to cause global macroeconomic effects.

One hopes that developments hereafter err towards longer-term peaceful solutions to decades of conflict.

Interest rates remain unchanged, but for how long?

Meanwhile, the US Federal Reserve (Fed) declared its interest rates remain unchanged; Chair Powell was keen to stress they “weren’t even thinking about thinking about cutting rates yet”, but the signals were strong that, having used exactly the same phraseology about raising rates in mid-2020 (arguably rate rises should have started then and ended earlier) this is the end of the rate-rise cycle. However, data published at the end of October surprisingly concluded that the US economy grew at an annualised rate of almost 5% in the third quarter; there remained more vacancies than unemployed, while falling inflation gave consumers the confidence to freely spend excess savings remaining from COVID on holidays and other services. These are not conditions that stimulate central bankers to loosen financial conditions by cutting interest rates.

UK and European interest rates were similarly held as headline inflation rates continue to retreat, although less quickly than hoped. The British Retail Consortium’s shop price inflation fell by a percentage point to 5.2% in October. The Bank of England expects the economy to flatline for the next 12 months, while inflation expectations for 2024 are higher than they were earlier this year. The former implies downward pressure on rates to stimulate a moribund economy, yet the latter suggests interest rates will remain at this level for some time. This is not the only example of data producing mixed messages for investors.

Mismatch between economic data

There has been a striking mismatch between ‘official’ economic data that suggests financial conditions are tight (e.g., high interest rates, money hard to borrow), and investors’ behaviours. Equity indices have weakened but remained positive, and yet bond yields rocketed. Consumer spending (especially in the US) is high, and wages are rising (US auto workers just won a 25% pay rise over 4 years). Investors have been moving out of defensive, quality companies and returning to those previously eschewed due to fears of recession. High yielding “Junk” bond prices are as high as they’ve been since early 2022.

If conditions are so tight this makes little sense (to me at any rate).

We have made the point before that our notions of ‘high’ and ‘low’ in terms of interest rates and inflation may be based on market participants’ most recent experience (e.g., the last 20 years). For those of us who remember conditions prior to 1982, their sense of adjectives and comparators (high and higher, for example) may be different. Historically, speaking, financial conditions by one measure - the Chicago Fed National Conditions Index - are roughly equivalent to those prevailing 50 years ago – a little loose.

However, that uses market data (various bonds’ yields), which can be regarded as a proxy for risk appetite. An alternative (from Gavekal Research) which focuses on what we all actually experience, e.g., the difference between the cost of borrowing and the return on lending, credit availability and housing affordability, suggests despite some recent relief, conditions are still tighter than in 2008. Bearing in mind interest rate tools can take 2 years to have their full effect, a recession can’t be ruled out yet.

Until next time, have a good month everyone.

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