Current market developments show that traders are expecting a victory for the US Federal Reserve in the fight against inflation – although risks have increased in light of the attack on Israel.
• Bond market expects Fed to win battle against inflation
• Terrorist organization Hamas causes terrible bloodbath in Israel
• Intensification of the Middle East conflict increases risks for inflation and growth
Bonds have recently come under fire because the Fed has signaled a possible further increase in interest rates. This is due to the fact that in the case of a tighter monetary policy future bonds would have a higher interest rate than current securities and the newly issued bonds would therefore be more attractive for investors. Therefore, demand and thus also the prices of “old” US bonds are falling, while their yields, which are developing in opposite directions, are rising in return.
Victory expected in the fight against inflation
But on Tuesday, following Hamas’ devastating attacks on Israel, the selloff in U.S. Treasury bonds was curbed and yields fell sharply. According to “MarketWatch”, this development is due to the fact that the dominant hope among market participants is that the US monetary authorities will not decide on any further interest rate increases in November, December or January.
Interestingly, this is happening at a time when Israel has officially declared a state of war. The Middle East, with Saudi Arabia, Iran and other important oil-producing countries, is one of the richest oil-producing regions in the world. If tensions arise there, risk premiums on the oil market usually rise significantly and quickly. But oil prices have calmed down after a brief bounce, suggesting the market believes the war’s impact is limited for now. The movement in oil “has been contained so far,” MarketWatch quotes Lawrence Gillum, a strategist at broker-dealer LPL Financial, as saying. “But if the conflict widens to include Iran and a 1973-style oil embargo, we could see rising inflation. Bonds aren’t really pricing that in at the moment. The bond market is expecting the Fed to lead this fight against inflation wins.”
Risks due to the Israel war
But if the conflict in the Middle East spreads, there is a risk of huge impacts on the supply of oil from the Middle East. There is speculation that Iran, as the main supporter of Hamas, will play a key role in the worst bloodbath since the founding of Israel, which is why it is now more likely that the US will enforce sanctions against Iranian oil exports more strictly. In addition, Iran is located on the Strait of Hormuz, through which a large proportion of the region’s crude oil is transported. Tehran has threatened to block the sea route several times in the past. Therefore, the conflict poses “the risk of higher oil prices and therefore risks to both inflation and growth prospects,” as Karim Basta, chief economist at III Capital Management, explained, according to FORTUNE.
Fed’s dilemma
The inflamed Middle East conflict is thus increasing the US Federal Reserve’s dilemma. It is attempting a difficult balancing act with its monetary policy because higher interest rates help to dampen inflation, but at the same time they can slow down economic growth and even lead to a recession.
As can be seen from the minutes of their September meeting – which, incidentally, took place before the major attack on Israel – a large majority of US monetary authorities continue to assess future economic developments as highly uncertain. This speaks for a cautious approach to interest rates, it said in the minutes. This uncertainty is likely to be exacerbated by the terrorist attack on Israel and its possible consequences.
Editorial team finanzen.net