Understanding the implications of war

Economic data

Markets were mixed this week following the horrific terrorist attacks in Israel over the weekend. Of course, it goes without saying we send our condolences to the families and friends of ?victims of last week’s attacks, and we hope for peace to minimize the loss of innocent life. Israel’s declaration of war on Hamas prompts us to ask questions surrounding the length and magnitude of Israel’s military operation and how it will further impact global relations and financial markets. As one would expect, early in the week global government bond yields quickly moved lower and energy prices moved higher. However, risk markets (both stocks and corporate spreads) conversely improved, likely due to the easing of interest rates, but also signaling expectations the implications of the Middle East conflict would likely be contained to the region. This possibly reflects the fact markets have become accustomed to global wars and regional conflicts. In recent years, these have not caused global market meltdowns. Unfortunately, it’s too soon to understand the full ramifications of the war. What seems clear is markets are pricing in minimal spillover, but we can’t disillusion ourselves, as it could run the risk of expanding.?

On the economic front, US data focused on inflation this week, with both Consumer Price Index (CPI) and Producer Price index (PPI) coming in modestly higher than expected. This further supports the thesis that, while easing, inflation will remain above the 2% target of the Federal Reserve (FED) for some time, especially as the strong labour market continues to underpin consumer demand. US CPI was unchanged in September at 3.7% year-over-year (Y/Y). The core number (excluding food and energy) modestly declined from 4.3% to 4.1%. It’s worth noting that the bulk of core inflation now pertains to shelter. Shelter rose in September by 0.6% month-over-month and accounts for more than 43% of the category. Excluding shelter, core CPI rose by 0.1% on the month and now stands at 2.0% Y/Y. This is more in line with the Fed’s target and more reflective of discretionary items in the consumer basket. We also saw real average hourly and weekly earnings trend lower, showing weakness in consumer purchasing power and supporting expectations of further easing of inflation over time. Still, the bond market reacted negatively to the data, causing yields to move higher and supporting the argument of interest rates staying higher for longer. Canadian data was light on the week. Building permits came in higher than expected at 3.4%, However, this was entirely attributed to non-residential structures, with housing permits falling by 3.7%. This continues to be a major issue, especially if we account for Canada’s immigration policy and its shortage of housing. Still, Canada’s housing remains weak, thanks to much higher interest rates. Existing home sales declined 1.9% in September.?

Bond market reaction

Bond yields were mixed on the week, first moving lower in reaction to increased geopolitical risks associated with the aforementioned war, but then reversing course due to higher-than-expected inflation data leading to the poor performance of both the US 5-year and 30-year Treasury bond auctions. However, credit spreads seemed little shaken by increased global conflict and reacted more to the daily directional moves in interest rates. Specifically, credit spreads reacted favourably when yields moved lower. We see this as a sign risk markets are becoming increasingly concerned about the absolute level of government bond yields. Still, appetite for credit remained intact this week with several new issues coming to market with what seemed like little-to-no new issue concession.?

Stock market reaction

Equity markets this week shrugged off events that typically would result in volatility: sharp moves in bond yields, better-than-expected employment data in the US and conflict in the Middle East. Aside from macroeconomic and geopolitical events, this week saw a continuation of trends from the last few months. We have spent time in the past talking about a class of diabetes and weight-loss drugs called GLP1s. Earlier this week, more research data emerged suggesting improved outcomes for patients with chronic kidney disease. This suggests expanded usage of the existing drug. It’s been remarkable to see the knock-on effects to other sectors, including Consumer Staples. This sector has seen an approximate 12% drawdown in the US since early August. There’s also been an approximate 22% decline in medical devices over a similar time frame. On another note, Microsoft finally received clearance from the UK’s competition bureau for its proposed acquisition of Activision. Most geographies were comfortable with the deal, but the UK regulatory body was a roadblock for the past few months over concerns that their merger would empower the Xbox franchise disproportionately vs. its peers. In the process, Microsoft agreed to shed some assets to Ubisoft, keep prices competitive and ensure cross-platform development for Activision’s core portfolio.?

What to watch next week

Next week in Canada, we’ll get wholesales sales, manufacturing sales, the Bank Canada’s business outlook survey, housing starts, CPI and retail sales. In the US, we’ll see the monthly budget statement, retail sales, industrial production, business inventories, building permits, existing home sales and housing starts.

Authors: Adam Ditkofsky, Pablo Martinez, Sandor Polgar, Steven Lampert, Craig Jerusalim and Rahul Bhambhani

Adam Ditkofsky is Senior Portfolio Manager, Global Fixed Income; Pablo Martinez is Portfolio Manager, Global Fixed Income; Sandor Polgar, Portfolio Manager, Global Fixed Income; Steven Lampert is Associate Portfolio Manager, Global Fixed Income; Craig Jerusalim is Executive Director and Portfolio Manager, Equities; and Rahul Bhambhani is Portfolio Manager, Global Equities.

The views expressed in this document are the views of CIBC Asset Management Inc. and are subject to change at any time. CIBC Asset Management Inc. does not undertake any obligation or responsibility to update such opinions. Certain information that we have provided to you may constitute “forward-looking” statements. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or achievements to be materially different than the results, performance or achievements expressed or implied in the forward-looking statements. This document is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this article should consult with his or her advisor. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change with the exception of bond data, which is as of end of day the previous Thursday, and equity data, which is as of mid-day Friday. CIBC Asset Management and the CIBC logo are trademarks of Canadian Imperial Bank of Commerce, used under license. The material and/or its contents may not be reproduced without the express written consent of CIBC Asset Management Inc.