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Market Update
October 16, 2023

Lots Of Uncertainty

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Week Ending 13 October, 2023

It was quite a week in economics and politics. As if uncertainty around interest rates wasn’t enough, last week saw a massive flare-up between Israel and Gaza (more on that below).

Global markets reacted quite mixed – equities notched up one of their best weeks (see table below) while bonds seesawed. Bonds prices started rising (i.e. yields falling) but this actually had more to do with short covering (technicals) fuelled by a flight to safety. Bonds then regained some of their losses. News flow was roiled by US inflation data which showed a steady increase again and has reinforced rate hike expectations. Some highlights from this September data print:

1. Core inflation rose +0.32% m/m, +4.1% y/y (a -0.20% decline).

2. Used cars contributed -0.09% m/m. Further declines are expected in coming months though the recent auto-strikes has introduced uncertainty over how much.

3. The sharp decline in OER (Owners’ Equivalent Rent) inflation saw a jump of +0.56% m/m (August: +0.38%, July: +0.49%). The rebound could be down to a boost from the imputation of utility prices.

4. Rent inflation edged slightly higher to +0.49% m/m (August: +0.42% m/m).

5. Travel (lodging +3.7% m/m, airfares +0.3% m/m) and hospital services (+1.5% m/m, largest monthly increase since 2016) were firmer than expected and contributed to a sharp acceleration in core services prices excluding rent and OER (+0.61% m/m vs. prior three-month average +0.18%). Overall, inflation breadth widened.

6. Car insurance inflation remained strong (+1.3% m/m) insurers continue to pass through the lagged impact of higher repair and replacement costs.

7. Headline inflation rose +0.40% m/m (food increased +0.2% m/m but energy prices jumped +1.5% m/m).

Energy prices gained on fears Israel might take out Iran (a major oil producer). Brent shot up over +5% while European gas prices have surged almost +40% marking the largest, weekly rise of the year so far. Gold shone (best week since mid-March) for its safe-haven status.

Making sense of the recent Israel-Gaza situation. For sure it is a crisis. It is part of the much wider Israel-Palestine issue whose roots go back to land rights following the 1947 UN Partition Plan. In this week’s weekly, I am not delving into who is right or wrong. I am merely interested in where we are and how things play out from here. I will make this point though: Israel’s attempts at trying to flatten Gaza every time there is a flare-up is utterly futile. Anyone who has ever tried to clear weeds in a garden will know that. They keep coming back….and the clear-up becomes more and more expensive (financial, economic and human cost) with the passage of time.

Reviewing various commentaries, articles and interviews, here are some reasons for what might have given rise to these attacks:

8. Recently, Israel has been a very politically and socially divided country. Past governments have survived by fragile coalitions. More so, Netanyahu’s time in office has been riddled in accusations of corruption. Most importantly, his plans around changing the judiciary have stirred up real anger resulting in numerous protests. It can be likened to what’s going on in Poland and Hungary where similar attempts have been made with their own legal systems. The effect of all this, allegedly, was to catch the country with its guard down resulting in a deep lapse in vigilance. It has been cited the country’s security forces (IDF = Israeli defence Force) had become complacent and as a result were caught totally by surprise while Hamas had put together a well-planned attack. That combination led to horrors all round. This is similar to the accusations that followed 9/11 in the US.

9. It has also been said the path to peace, over recent years in the Middle East (ME), has left Palestinians feeling sidelined and vulnerable and with a sense that their cause is being forgotten (see reference above about the Partition Plan). The argument goes recent peace efforts in the ME (which have been focused entirely on the Abraham Accords) while talking about peace quietly and conveniently forgets about the Palestinian problem.

10. The finger, by both Israel and the West, has been pointed firmly at Iran for helping to orchestrate and facilitate these recent attacks. Iran, for a long time, has sponsored Hamas (Gaza) and Hezbollah (South Lebanon) as well as militants in the West Bank. It is argued that the Abrahams Accord (referred to above) and, especially the progress that was being made between Israel and Saudi Arabia, left Iran feeling insecure & vulnerable about its role and position. Prior to these attacks, Saudi had always made it clear it would not let its pursuit of a defence pact with the US be derailed – even if Israel refused to make significant concessions to the Palestinians in their bid for statehood. Saudi and Israel had been moving towards a deal that could have reshaped the middle east.

Where are we now?

11. Israel has completed stage I of its offensive. It now wants to launch stage II – a ground invasion of Gaza to set free Israeli hostages while also removing Hamas in its entirety. It has “urged” Palestinian civilians in Caza City to relocate south of the Gaza river within 24 hours warning of significant military activity. The UN has said this will be impossible. There are 1.1mn people living in northern Gaza.

12. Saudi Arabia has switched its focus from doing a deal with Israel to doing a deal with Iran. For Israel and the US, the normalisation of relations with Saudi is seen as really important and far exceeds, in importance, that with Bahrain, Morocco, Sudan and the UAE combined. Saudi has significant economic influence and religious importance in the Arab world. During the Al-Aqsa Intifada of 2000, Oman and Qatar (both of whom had been early supporters of trade cooperation with Israel in 1994 and 1996 respectively) immediately decided to close their commercial representation offices in Israel. Both Qatar and Oman firmly blame Israel for the latest attacks. It is reported both leaders of Saudi and Iran have already spoken with each other. A senior Iranian official described it as being “good and promising”. Sources close to Saudi’s thinking have said talks cannot be continued for now and that Palestinian concessions would have to be a bigger priority when discussions resume. The latter indicates Saudi has not abandoned the idea of continuing talks.

13. The US has asked, through its contacts that have channels into Hamas and Hezbollah (including via Iran), to help get hostages released and step down from further activity.

14. Neighbouring countries are nervous: Egypt does not want waves of refugees spilling over from Gaza. The UN and US have been quick to provide assistance in anticipation of this. Turkey’s role will be key as it seeks to mend its tarnished relations with regional states, including Israel. It has issued a very balanced response as it tries to maintain a non-confrontational approach given the dire state of her economy and need for foreign capital (from both her charm offensive in the ME as well as from the US/EU). Turkey’s previous position has been pro-Palestinian. Erdogan has just come through a close election victory and is trying to be a different statesman to before. He can’t dismiss the pro-Palestinian sentiment back home.

15. Morocco’s normalisation with Israel will be tested. Morocco is a major non-NATO ally as well as most closely aligned with the US. Its response has been muted (as expected) and stops well-short of any full-blown rhetoric towards Israel. By contrast, Algeria and Tunisia have taken a confrontational stance towards Israel.

16. Although Russia has good relations with Israel, Iran provides Russia with sophisticated weapons which it uses in its war with Ukraine. The likelihood is Russia, which has its own problems, will lean on Iran’s side. It is unlikely to be able to do anything militarily.

17. What of China? Initially, their statement did not condemn Hamas (which offended Israel). Instead, it urged both sides to “exercise restraint and embrace a two-state solution”. China is walking a tightrope, especially as it trades with Israel over hi-tech goods. It then released a statement more explicitly condemning harm to civilians. For China, it’s a long game. They are aligning themselves with countries in Africa, Latam and others who see Palestine as a struggle akin to “an Israeli apartheid policy” and, as a result, has long been a supporter of the Palestinian cause. It was amongst the first to recognise Palestine. China still has influence in the region – it helped restore diplomatic relations between Saudi and Iran both of whom support Palestine – but it does not have significant influence. By contrast, the US has been fostering talks towards normalisation between Saudi and Iran and has more stature in the region despite Biden’s gaffs.

What happens next? The answer to this is in two parts:

18. How long Israel’s ground war lasts. Gaza is a strip of land measuring 25 miles long and between 4 to 6 miles wide. Will Israel stop once it is able to get the hostages freed? Or, more likely, will it try to wipe out Hamas? If the latter, we are talking of a full-on invasion with unimaginable casualties in Gaza. I can’t see the rest of the world standing idly by and watching. If Israel goes all-out in Gaza, it has to change mindsets both in the ME as well as beyond.

19. Iran: What happens if it is proved (with sound evidence I hope and not the farce we all witnessed over Weapons of Mass Destruction with Iraq under Sadam Hussain) that Iran was directly involved? Then it turns really nasty - Israel will go all out for Iran. The US already has an aircraft carrier stationed of Israel’s coastline and another is en-route. Their presence would be to stop any possible retaliation by Hezbollah – and any counteroffensive by Iran. At this point, nations will have to take sides!

Source: LSEG Datastream/Fathom Consulting
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