Horror, Despair, And Improved Market Sentiment

By Jane Foley, head of FX strategy at Rabobank

Air raid warnings were reported to be sounding across Israel yesterday as rocket attacks continued during the day. In response to the shock assault from Hamas on Saturday, Israel carried out retaliatory strikes and prepared to put Gaza under a ‘complete siege’ with no deliveries of electricity or food. The initial market reaction was to be expected, defense stocks found support, the safe haven CHF was the best performing G10 currency on a 1-day view, gold prices surged, bond futures moved higher and the value of the shekel slumped, triggering a pledge by Israel’s central bank to sell as much as USD30 bln foreign exchange and extend up to USD15 bln through swap mechanisms to support confidence.  Additionally, oil prices jumped 3% or so, cutting short the downtrend that had started at the end of last month but falling short of any sign of panic.

The lack of any stronger reaction quickly turned to relief with the turnaround in sentiment supported by a more dovish tone from a couple of Fed officials. Jefferson is viewing current Fed policy as restrictive and now sees the Fed proceeding carefully. Logan suggested that the recent surge in treasury yields may reduce the need for more policy tightening. By the end of Monday’s trading session, US stock indices had turned higher. This morning, equity futures are mostly up, bond yields are pushing lower, the shekel has recovered some ground and oil prices are trading below yesterday‘s high. Crucial for the outlook for oil, and therefore for inflation, will be the extent to which the war between Hamas and Israel impacts the broader Middle Eastern region.

EU foreign ministers will hold urgent talks today to address the situation in Israel and in the region. Yesterday it was announced that the EU is putting all of its development financing for Palestine under review in response to the attack by Hamas over the weekend. The current budget is reportedly around EUR691 mn. 

The US announced that it is moving an aircraft carrier, ships and jets to the eastern Mediterranean and has also pledged to give Israel additional military equipment and ammunition. The large deployment reflects concerns that the conflict could draw in other parts of the region. 

The deployment aside, speculation is centering around additional sanctions against Iran as one of the first responses. Over the weekend, the Wall St Journal reported that Iranian officials helped plan the attack on Israel and gave the green light for the assault at a meeting in Beirut last Monday. White House officials have not confirmed there is evidence of Iran’s involvement but do say that Iran was complicit, while a top US General is warning Iran not to involve itself in the Hamas/Israel war. The WSJ report speculated that the weekend attack was timed to coincide with internal political divisions in Israel and to disrupt US brokered talks between Saudi Arabia and Israel which Iran viewed as threatening. Even if the US does tighten sanctions on Iran, however, the issue of enforceability remains, with much of Iran’s oil destined for China. 

There is plenty of scope for the situation to impact US politics. While the Biden administration is arguing that the attack by Hamas highlights the need for an experienced leader in the White House, his political opponents have been critical of the President’s handling of US foreign policy.  In the short-term, the absence of a Speaker means that the House of Representatives cannot properly function. This could slow any attempt to support Israel as well as delaying crucial domestic issues such as funding the government beyond the middle of November.