Perspective: Morning Commentary for October 7

October 7 – It was one year ago today that Hamas attacked Israel, killing 1,200 people and taking 250 hostages with them back into Gaza. That war continues to escalate one year later. The risks associated with that war, combined with data forcing Wall Street to rethink its Federal Reserve rate cut expectations, led to weaker stock futures overnight. The VIX traded to a one-month high near 21 this morning, while the dollar index continues to contain some safe-haven premium as its trades near 102.5. Yields on 10-year Treasuries are trading near 4.01%, while yields on 2-year Treasuries are trading near 3.99%. Crude oil prices are 1.5% higher trading above $75 per barrel this morning, while the grain and oilseed markets traded mixed to weaker overnight, with corn and soybean prices reflecting rapid harvest progress for this year’s big crops seeking storage space.

Hamas’ attack on Israel a year ago triggered a massive invasion of the Gaza strip by Israel, and a war that rages on to this day as it seeks to return every last hostage. Meanwhile, Hezbollah increased its attacks on Israel from Lebanon in support of Hamas until Israel had enough, and it began striking at Hezbollah leadership with strategic attacks, followed by last week’s ground invasions into parts of Lebanon as it intensified air attacks on points much deeper into Lebanon. Iran stepped in last week in defense of its proxy groups to directly attack Israel with at least 180 missiles. Israel promised that it would retaliate against Iran at the time and in the way of its choosing, risking that this one-year-old war will continue to spread regionally in the Middle East.

Iran’s oil and nuclear infrastructure are potential targets of Israel when it chooses to carry out its retaliation, which could certainly reduce the amount of exportable oil available to the world. OPEC+ has the spare capacity to make up that lost oil, should it occur, but the energy balance sheet would become more challenging if Iran would then retaliate by attacking Saudi Arabia’s energy infrastructure, as it did in 2019, and/or if the Strait of Hormuz would get closed, through which 30% of the world’s oil exports pass daily. This is why crude oil prices have been building risk premium into the market as geopolitical risks intensify between Israel and Iran. Until now, Israel has been fighting Iran’s proxy fighters, but now this war is increasingly becoming one directly between Israel and Iran, which significantly increases the human, economic and energy risks.

What will the Federal Reserve do next? That’s the question haunting Wall Street. It was all prepared for a collapse of the Fed’s benchmark overnight rate to 3%, or perhaps lower, when the data started raising questions about the Fed’s ability to grant that wish. That was reinforced this past week when Fed Chair Jerome Powell struck a much more hawkish tone when speaking at a public event. A strong jobs report reinforced Fed cut doubts on Friday, with Fed fund futures now trading the likelihood of just two 25-basis point rate cuts the rest of this year, while some are now starting to question whether that will even happen if the data continues to come in strong. We’ll get key inflation data later this week when the consumer price index is released on Thursday and the producer price index is released on Friday. We’ll also see another jobs report before the Fed meets again next month. The inflation data will likely continue to show movement toward the Fed’s 2% mandate in September, but there are good reasons to be concerned whether that trend will continue in future months, particularly if energy prices continue to rise.

The U.S. economy continues to operate in a manner that is somewhat disconnected with the case studies of the past. The current economy is less affected by current interest rates, which are frankly still below long-term averages, while continuing to receive heavy doses of fiscal stimulus. Much of the weakness in inflation in recent months is tied to deflationary trends in commodity prices, but now those commodity prices are rising, led by energy prices. Energy impacts everything that we do, including freight, packaging, etc. Add to that the string of wage negotiations seen in recent months, and wage inflation is starting to return as well. That’s why I have consistently argued that it would be a mistake for the Fed to quickly move rates down toward the 3% level, which could trigger another round of reinflation. Last week’s comments by Powell seem to suggest that the policy group is now aware of those risks, and Wall Street seems to be sensing now as well.

The Midwest should remain mostly dry and seasonally warm over the next two weeks. That continues to encourage a rapid dry down of this year’s corn and soybean crops. Farmers save drying costs when they allow corn to dry in the field, but crops that dry down too much in the field also cost them money. As such, they are working around the clock to bring this year’s crops in, creating challenges for storage space, which pushes bushels onto the market. That creates downward pressures on cash basis, while also creating pressure for futures. Rains are still coming to Brazil this week, although totals have been dialed back modestly.