A Chill Descends

By Aoifinn Devitt, CFP® – Chief Investment Officer

Temperatures are dropping, leaves are turning and everywhere there is a chill in the air.  The tragic events playing out on the geopolitical stage, now in the Middle East, are adding to the ledger of geopolitical negative surprises behind market conditions that were just themselves starting to cool. We cannot overstate the humanitarian disaster that is unfolding, but to learn from and analyze these events we must reflect on the dangers of missing the forest for the trees, complacency, and insular thinking.

The “September effect” in markets was already a chilling one.  Markets displayed four negative weeks in a row before reversing this trend just last week when growth, again, was ascendant after the blowout US jobs report. 336,000 new jobs were added in non-farm payrolls, the highest number since January 2023, with the last two months also revised upwards.

Source: Morningstar as of 10/10/23


This trend seemed only to cement the interest rates “higher for longer” trend with rates on the 10-year breaching 4.79%, its highest level since 2007, and the 30-year topping 5%.  This is the yield curve we used to know, behaving as it should. For some, however, this gap out in longer dated yields evinced a lack of confidence in governments – a wariness around political deadlock and a belief that central banks would not be swooping in to stimulate the economy via a rate cut anytime soon.

The events in Israel were described as “epochal” and a “watershed moment,” and some commentators reflected that, like other aggressive geopolitical events, it occurred against a backdrop of a very high oil price – asking whether perhaps that emboldens aggressive moves by oil producing nations? The oil price did move upwards notably after the news of the declaration of war over the weekend, but not as dramatically as might have been expected.  Many commentators noted the shift in oil market dynamics since the Yom Kippur war in 1973 – when the US was much more dependent on the region and alternative energy sources were less in demand.  This time around the US is far more self-sufficient in terms of its energy sources, while the pervasive geopolitical tensions as well the availability of alternative energy have lessened the dependence on middle East sourced oil.   There is also the all-important matter of supply and demand.  With the US dollar already at close to 22-year highs, and on the back of further steady month-on-month increases since July, oil was already looking extremely expensive to non-USD buyers.  Demand was suffering and the price was starting to roll over.

Now it remains to be seen where the oil price goes from here.  Geo-political uncertainty is sure to wreak havoc on estimates and forecasts – and a rising oil price will drive inflation higher, as well as putting pressure on corporate margins and the consumer wallet. It is not so clear, however, that inflation driven by energy costs will bother the Fed as much – as monetary policy can’t really have an effect on supply-side inflation such as this.  It may, as was done around the time of the regional banking crisis, decide to “wait and see” when it comes to energy-driven inflation.  If inflation otherwise continues the downward trend it has been on, we see no reason for the Fed to suddenly get more hawkish when it comes to rate rises.

Much of this is because the full transmission effect of the unprecedented pace of the last 11 rate hikes has still to be felt. Many consumers are not exposed to the full brunt of the highest mortgage rates in 22 years, and not all consumers are borrowers.

Markets seem mixed as to what to expect. Like oil, just recently 10-year Treasury yields also had fallen from their peak.  We had seen some limits in effect.

Together, the tight labor market, strength of the dollar, high oil prices, and return to predictable bond yields might feel like a flashback to the early 1970s, but it also indicates that the risk of a true recession is low. The consumer remains resilient, there are indications that the upcoming earnings season will bring good festive cheer and the employment picture remains strong. This is positive for portfolios with their current mix of assets. We are always on guard for the potential for a severe negative surprise – whether that comes from geopolitics, or, more critically the current economic balancing act. However, although the news backdrop is more unsettling, more shocking and more unprecedented than ever, we find ourselves watching, and waiting.



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