Geopolitical Risk Premium Eases

October 28, 2024

Geopolitical Risk Premium Eases

  • Crude oil prices plunged by over 5%. Israel spares Iran’s oil infrastructure in retaliatory attack.
  • JPY is underperforming on heightened political uncertainty in Japan.
  • There are no policy-relevant economic data releases today.

Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.

USD and Treasury yields face additional upside traction underpinned by a strong U.S. economy. U.S. real GDP growth (Wednesday) is expected to print at 3.0% SAAR in Q3, which is above the pre-pandemic average annual growth rate of 2%. Risks are balanced as the Atlanta Fed GDPNow model estimates Q3 growth at 3.3% SAAR while the New York Fed GDP nowcast model estimates Q3 growth at 2.9% SAAR.

The U.S. October non-farm payrolls report (Friday) will be hard to interpret as it will be affected by the two recent hurricanes and the strike at Boeing. Still, we expect this week’s U.S. jobs data to remain consistent with a labor market soft-landing. The Dallas Fed manufacturing activity index is up next (2:30pm London),

Crude oil prices plunged by over 5%. Israel’s response to the ballistic missile attack by Iran on October 1 was more restrained than expected. Israel struck multiple military targets rather than Iran’s oil infrastructure or nuclear facilities as was feared. The prospect of a full-blown war between Iran and Israel may have diminished but it remains a significant source of geopolitical risk.

JPY is underperforming on Japan political uncertainty. The ruling Liberal Democratic Party (LDP) and its junior partner Komeito unexpectedly lost their majority in parliament. LDP and Komeito now have 215 seats which is short of the 233 seats needed to control the lower house. The main opposition center-left Constitutional Democratic party (CDP) and all non-affiliated lawmakers have 250 seats. LDP and CDP now have 30 days to find one or more coalition partners to form a government.

The math favors an LDP-led government. Nevertheless, political gridlock means it will become much more difficult for Prime Minister Ishiba to move forward with fiscal and monetary tightening. Some observers also feel that Ishiba will be severely weakened as LDP leader and may be challenged ahead of upper house elections scheduled for next year. Stay tuned.

In the meantime, the Bank of Japan (BOJ) loose for longer policy stance remains a drag on JPY. The BOJ is widely expected to leave the policy rate at 0.25% Thursday. We also expect the BOJ to signal again that it’s in no rush to remove policy accommodation. Japan economic growth is unimpressive, underlying inflation is in a firm downtrend, and BOJ officials continue to caution about unstable financial markets.

China’s benchmark CSI 300 Index remains range-bound, and USD/CNH is trading near the top-end of two-week 7.1000-7.1500 range. Investors are waiting for details of China’s fiscal stimulus pledge. Specifics are expected to be released following the National People’s Congress Standing Committee meeting scheduled for November 4 to 8.

GBP/USD is holding under 1.3000. U.K.-German 10-year government bond yield spreads narrowed slightly but remain historically wide. Chancellor of the Exchequer Rachel Reeves will present the budget Wednesday. Investors fear the government will fund increased investment spending with higher debt issuance after confirming tweaks to budget rules to include government assets in the U.K.’s measure of debt. Greater risk premium on gilts is a drag on GBP, especially on the crosses. The U.K. October CBI Distributive Trades Survey is today’s data highlight (11:00am London).

EUR/USD is trading heavy around 1.0800. ECB Governing Council Member Pierre Wunsch speaks (9:00am London). Last week, Wunsch pushed-back against discussion on a 50 bp cut in December saying, “I think really it’s premature.” Still, markets are pricing-in 37% odds of a 50 bp cut in December. Stagnating Eurozone economic activity and quickening disinflationary pressures support the case for the ECB to speed up its easing cycle and can further weigh on EUR.

USD/CAD has scope to sustain a break above key resistance at 1.3900. Bank of Canada Governor Tiff Macklem suggested last Friday there’s still plenty of room to ease policy. Macklem noted “we have a flexible exchange rate that allows us to run a monetary policy that is suited for the Canadian economy…There are limits to how big that difference can be, but we're not close to those limits, and those limits are not factoring into our current policy decisions.”

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