By Benjamin Picton, senior macro strategist at Rabobank

Old World, New World

Yesterday was a day of contrasts. The ECB left the deposit rate unchanged at 4%, citing a weakening labour market, weak growth and further risks to the outlook from geopolitical factors. Meanwhile, the USA recorded annualized 3rd quarter growth of 4.9%, substantially higher than the consensus estimate of 4.5% even as the core PCE deflator fell by more than expected to just 2.4%.

The S&P500 closed down 1.18%, and the EuroStoxx 50 was down 0.59%, so it looks like equity markets think good news is bad news in the New World, and bad news is bad news in the Old World. 10y US Treasury yields reversed Wednesday’s strong gains to close down 11bps at 4.84%, Brent crude fell 2.44%, and USDJPY experienced a flash crash after touching 150.78 (I keep saying to keep your eye on Japan).

While the decision to leave rates unchanged in Europe was widely expected, there was speculation that the ECB might announce changes to the PEPP program (the pandemic era bond-buying scheme) or the minimum reserve requirements (MRR) of commercial banks. The ECB has been reinvesting the proceeds from maturing securities bought under the PEPP and plans to do so until the end of 2024, but some commentators thought that deadline might be brought forward to accelerate reductions in the ECB’s balance sheet and further tighten financial conditions.

In the end, no changes were made. The ECB seemingly sees no pressing need to accelerate monetary tightening, which is probably fair enough considering that the Eurozone composite PMI released earlier this week was the lowest since November 2020.

In her press conference Christine Lagarde was at pains to point out that economic weakness does not mean that rate cuts are imminent. Indeed, she said that inflation was “expected to stay too high for too long” and the ECB could hike again if required.

We think the lady doth protest too much. Our experts on the European economy say it is already in recession and that we will see no further hikes from the ECB.

While the stonking GDP print stole the headlines in the USA, there was plenty of strength to be found in other data as well. Durable goods orders in September rose by 4.7% versus expectations of just 1,9%, new home sales in September exceeded expectations by 79,000, initial and continuing jobless claims were both lower than the consensus forecast and the goods trade balance was a little better than expected. Many of these data points saw the previous month’s figures revised stronger, too.

This is all important data, but geopolitical concerns continue to dominate in the halls of power, if not yet in Wall Street dealing rooms.

Israel launched a series of ground raids on targets in Northern Gaza as Prime Minister Netanyahu warned that “this is only the beginning” and that Hamas was “doomed”. This indicates that market optimism earlier in the week that Israel would not launch a full scale ground invasion is misplaced. Boots on the ground has only been delayed at the request of Joe Biden to allow time for the USA to put their own defence assets in place. Those assets are intended to deter Iran and Hezbollah from entering the war.

In the meantime, exchanges of fire in the region have intensified. US bases in Syria and Iraq have again been attacked by Iran-aligned militia, and Iran continues to threaten direct involvement in the conflict if (when) Israel pushes into Gaza. The FT also reported overnight that Qatar has sentenced eight Indian nationals to death on charges of spying on the Qatari submarine program on Israel’s behalf. What role might India play if goaded by a key Iranian ally?

While the main belligerents circle each other, other players in the great game are picking sides. China has just signed an agreement with Columbia to upgrade ties to a strategic partnership, Hamas has sent a delegation to Moscow, Joe Biden has warned that the US will intervene if China attacks the Philippines, Libya’s Eastern Government has called for an oil embargo against supporters of Israel, and the Australian Prime Minister has been in Washington doing deals on cyber-security, defence and critical minerals supply.

We expect more of this furious diplomacy in the coming weeks as emotions run high in the wake of escalation that now seems inevitable. This may have implication for trade flows and could mean that we start to see parallel markets developing for other commodities in the same way that there are now two markets for crude oil (those who get cheap Russian crude, and those who don’t). If that were to happen, it would make it all the more difficult to hedge market risk, but remaining unhedged on certain commodity exposures in an environment like this feels like a widow-maker trade.

What’s very clear by now is that we are in a dangerous New World of armed conflict and power politics, and financial markets will gradually adjust to that as structural changes occur.

The Old World isn’t coming back any time soon.