Market focused on implications of renewed geopolitical risk. Muted reaction so far. Fed speakers say they are mindful of the recent tightening in financial conditions

Conflict between Israel and Hamas that escalated over the weekend gripped the market’s attention as the new week kicked off. Weaker risk appetite initially enveloped markets, with asset prices initially moving in their typical direction after such a major geopolitical event – global equities weaker, oil prices higher, and bond markets receiving a safe-haven bid alongside the USD. But not all moves have been sustained, with the S&P500 now higher and the NZD surprisingly recovering up through 0.60.

Market focus has been on the implications of renewed geopolitical risks in the Middle East after Hamas attacked Israel over the weekend. Israel has declared war on Hamas, mobilised 300,000 reservists and has begun a “complete siege” of the Gaza strip. PM Netanyahu said “we are just getting started…we are going to change the Middle East”. Conflict has widened, with Israel also battling against militants on the Lebanon-Israel border.

As Asia opened for business S&P500 futures fell, US Treasury futures rallied, oil prices spiked up as much as 5%, risk currencies like the NZD and AUD fell, and the safe-haven USD rallied.

Not all moves have been sustained. While the S&P500 opened down ½%, it rallied back into positive territory and now shows a modest gain for the day. The Euro Stoxx 600 index fell 0.3%.

The small equity market reaction owes in part to lower global rates. US bond markets are closed for a public holiday, but Treasury futures have rallied strongly and are down about an equivalent 12bps for the 10-year rate. European 10-year rates are down in the order of 10-11bps.

Fed-speak will be cranked up this week with a number of scheduled speeches. Dallas Fed President Logan said that higher long-term rates mean less need for rate hikes viz “…if term premiums rise, they could do some of the work of cooling the economy for us, leaving less need for additional monetary policy tightening”. That looked like a dovish shift from an FOMC member who is seen to be more on the hawkish side of the spectrum, although she added that “to the extent that strength in the economy is behind the increase in long-term interest rates”, the Fed may need to tighten more.

Fed vice-Chair Jefferson said that the Fed is “in a position to proceed carefully in assessing the extent of any additional policy firming that ay be necessary…I will remain cognisant of the tightening in financial conditions through higher bond yields and will keep that in mind as I assess the future path of policy”. His comments came out at 6:30am and seem to have been a factor in lower rates, stronger equities and a weaker USD as we go to print.

Oil prices are up around 4%, with Brent crude trading just below USD88 per barrel after peaking at USD89. This is a muted reaction to the weekend events in the context of the more than 11% fall in prices last week. Whether oil pushes higher will depend on whether Iran is brought into the war. Intelligence reports suggest that Iran helped plan Hamas’s surprise attack on Israel but Iran’s representative to the UN denied that the country was involved in the attack.

In currency markets, the Israeli shekel has been the biggest casualty, falling over 2½% despite its central bank saying it would be prepared to sell as much as $30b of foreign reserves to defend the currency and extend up to $15b through swap mechanisms. For the majors, apart from a 1.1% gain in NOK, supported by higher oil prices, net currency moves have been modest and orderly.

JPY and CHF have received safe-haven bids, with USD/JPY down 0.4% t0 148.50 and USD/CHF down 0.4%. CAD has been supported by higher oil prices EUR and GBP show small falls. After a week-long holiday in China, the PBoC was back to its old tricks in setting a CNY reference rate some distance from market pricing. USD/CNH and USD/CNY both trade with a 7.29 handle.

The most surprising move has been support for the NZD. It opened the week lower and traded down to a low of 0.5961 in late Asia trading, but has recovered to around 0.6015, the Jefferson’s dovish comments adding to the earlier move up through 0.60. With a smaller gain for the AUD, NZD/AUD has pushed up through 0.94. The only vaguely positive news on the NZD was Fonterra’s 50c lift to the mid-point of its projected milk payout range to $7.25, but futures pricing has been above for level for several weeks and currently sits just under $7.90.

Domestic rates were kicked around by global forces yesterday, with NZGBs finishing the day down 1-5bps with some curve flattening. In the swaps market, the 2-year rate was unchanged at 5.72%, unwinding a fall earlier in the session and the 10-year rate fell 1bp to 5.33%. The global bond rally overnight will support a shift down in yields on the open today, with the Australian 10-year bond future currently down 10bps in yield terms from the NZ close.

In the day ahead, there are only second-tier data releases, with the market’s focus likely to remain on the conflict in the Middle East. Fed speakers continue to hog the wires and Governor Waller, one of the more respected FOMC members by the market, speaks early tomorrow morning on monetary policy.