Market Reactions to Political Changes

Market Movements in Japan

On Friday, markets were in a state of flux due to speculation over who would become the new Prime Minister in Japan. The USDJPY experienced a rally up to 146.49 based on rumors that Sanae Takaichi, known for her dovish stance on interest rates, was set to become the next Prime Minister. However, the currency fell significantly after it was announced that Ishiba, a supporter of BOJ policy normalization, had won the majority vote in a runoff. This news resulted in the Nikkei stock index selling off by more than 4% at the time of writing. Bitcoin also experienced a decrease. This is in contrast to the equities in China and Hong Kong, which are seeing a surge due to the ongoing excitement over the China stimulus bazooka.

US Treasury Yields and Canadian GDP

US Treasury yields were lower on Friday following the release of the August PCE inflation report. The headline PCE figure of 0.1% M-o-M was slightly better than expected, as was the Year-on-Year figure of 2.2%. Meanwhile, Canadian GDP surprised to the upside in July, continuing a recent trend of improved year-on-year growth readings in the monthly national accounts series.

Inflation Reports in Europe

The softer tone in yields was further influenced during the European session by soft CPI figures for Spain and France. Economists had expected a figure of 1.9% Year-on-Year for each country, but the actual number came out at 1.5%. This resulted in a shift in market pricing on a possible October ECB rate cut from just over 60% to more than 80%.

Developments in the Middle East

While markets were busy interpreting the implications of the PCE figures, significant events were unfolding in the Middle East. On Friday, Israel took out the leadership of the Shiite terror militia Hezbollah via a strike on its Beirut HQ. Israel also announced that Hamas is no longer a fighting force, and bombed the Houthis again, taking out port and oil facilities in Yemen. Iran has sworn revenge, but its options are limited. Doing nothing would clear the way for Israel to target Iran directly. A ceasefire with Israel would be a major strategic defeat and radical change in the Islamic Republic’s entire philosophy. Attacking Israel directly would mean war, with the US involved.

Oil Market Reactions

Despite the Israeli strikes on Houthi oil infrastructure, and the possibility of similar strikes on oil assets located in Iran, Brent crude is only up 0.7% to $72.49/bbl. This seems to be a continuation of markets pricing for perfection in all asset classes. Markets are now imagining a scenario where Iran and its proxies can take loss after loss - without a corresponding rise in oil risk premia - alongside a scenario where China stimulus simultaneously works for equities, house prices and (some) commodities, but does not spike oil prices that have been falling in part due to lack of demand in China.

Bottom Line

The weekend's events may have significantly shifted the geopolitical landscape, but it seems the laws of economics still apply. What are your thoughts on these developments? Do you think the market reactions are justified? Feel free to share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.