Middle East on the Brink

• The fog of war will likely continue to dominate financial market action in the near-term.

• The U.S. ADP September private sector jobs report is today’s data highlight. No policy-relevant EU or UK data releases.

• National Bank of Poland is widely expected to keep rates steady at 5.75%.

Financial markets are on edge amid heightened risk of a broader regional conflict in the Middle East. USD is firm near yesterday’s high, U.S. equity futures are down, global bonds are rallying, and crude oil prices are holding on to most of yesterday’s 8% gains. The fog of war will likely continue to dominate financial market action in the near-term.

Israel promised a “significant retaliation” to Tuesday’s ballistic missile attack on the country by Iran. Iran’s latest missile strikes came with far less warning than in April, raising the prospect of a full-blown war involving America, Iran and Israel. Indeed, US national security adviser Jake Sullivan called the Iranian attack “a significant escalation”.

Unimpressive U.S. economic data released yesterday did not move the dial on Fed rate cut expectations. The U.S. manufacturing sector contracted in September for the sixth consecutive month with the headline ISM index printing at 47.2, same as in August but below consensus of 47.5. The sub-indexes showed price pressures easing, the contraction in demand slowing and the downturn in employment quickening.

The U.S. August JOLTS data remained consistent with a labor market soft-landing. The Job opening rate rose 0.2pts to 4.8% and is above the 4.5% threshold that typically signals a significant rise in the unemployment rate. The details were mixed. The layoff rate ticked down 0.1pts to 1.0% and remains within the same narrow range that’s held for the past three years. However, the hiring rate dipped 0.1pts to 3.3%, matching June’s multi-year low, and the quit rate fell 0.1pts to 1.9%, lowest since June 2020, indicative of worsening workers confidence in finding a new job.

U.S. East and Gulf Cost dockworker went on strike yesterday. The impact on the U.S. economy will depend on the length of the strike. The last time East and Gulf coast dockworkers went on strike was in 1977, and it lasted seven weeks. The National Association of Manufacturers estimate daily economic losses of around $1.5 billion to $2.5 billion (or 0.005 to 0.009% of GDP).

The U.S. ADP September private sector jobs report is today’s data highlight and is expected at 125k vs. 99k in August (1:15pm London). Fed speakers include: Cleveland Fed President Beth Hammack (FOMC voter) (2:00pm London), St. Louis Fed President Alberto Musalem (2025 FOMC voter) (3:05pm London), Fed Governor Michelle Bowman (4:00pm London), Richmond Fed President Tom Barkin (FOMC voter) (5:15pm London).

French-German 10-year government bond yield spreads tightened slightly but are just 4 bp lower than the June high of 82 bp. French prime minister Michel Barnier confirmed that next week’s budget will include “time-limited and targeted” tax hikes. Barnier also delayed by two years the timing to bring the budget deficit, which is expected to hit 6% of GDP this year, within the 3% of GDP EU Stability and Growth Pact limit. Encouragingly, the leader of the far-right National Rally Marine Le Pen said her party would refrain from bringing down the government suggesting the budget may have a decent chance of passing in the National Assembly.

EUR/GBP can edge lower as the ECB has room to dial-up easing. ECB Governing Council member Martins Kazaks noted overnight that “recent data clearly point in the direction of a cut [in October]” but leaned against “exaggerated” market expectations for easing. Kazaks warned “rates still need to stay somewhat restrictive, and they will remain such even with some further cuts.” The swaps market has more than fully priced-in 150 bps of ECB rate cuts over the next twelve months. We expect the ECB to deliver those cuts because the Eurozone economy is stagnating, and inflation is undershooting the ECB’s 2% target. ECB Guindos, Kazaks, Lane, Elderson, and Schnabel speak today.

National Bank of Poland is widely expected to keep rates steady at 5.75% (between 1:00 and 2:00pm London). At the last meeting September 4, the bank kept rates steady, but Governor Adam Glapinski softened his stance noting a rate cut could happen after the middle of 2025 vs. 2026 previously. Other MPC members (Kotecki, Duda, Dabrowski, and Litwiniuk) also turned more dovish throughout the month arguing for the possibility of a March 2025 rate cut at the earliest. Kotecki and Wnorowski even suggested 100 bp of cuts over 2025 is likely. The swaps market is pricing in almost 125 bp of easing over the next 12 months.