The Overnight Report: Middle East Jitters

Array
(
    [0] => Array
        (
            [0] => ((CTD))
            [1] => ((KMD))
            [2] => ((CBA))
            [3] => ((BWN))
            [4] => ((BXB))
            [5] => ((CSL))
            [6] => ((EVN))
            [7] => ((EVT))
            [8] => ((GMD))
            [9] => ((HM1))
            [10] => ((IEL))
            [11] => ((IGL))
            [12] => ((IGO))
            [13] => ((LGI))
            [14] => ((NST))
            [15] => ((NWL))
            [16] => ((SNZ))
        )

    [1] => Array
        (
            [0] => CTD
            [1] => KMD
            [2] => CBA
            [3] => BWN
            [4] => BXB
            [5] => CSL
            [6] => EVN
            [7] => EVT
            [8] => GMD
            [9] => HM1
            [10] => IEL
            [11] => IGL
            [12] => IGO
            [13] => LGI
            [14] => NST
            [15] => NWL
            [16] => SNZ
        )

)

This story features CORPORATE TRAVEL MANAGEMENT LIMITED, and other companies.
For more info SHARE ANALYSIS: CTD

Middle East tensions and uncertainty continued to weigh on sentiment with US markets slipping on the first day of trading after the Labor Day holiday.

Focus remains on the US Aug PPI and CPI prints this Thursday and Friday, respectively.

The Australian market slipped to a 6-week low yesterday on concerns over further RBA rate hikes to curb inflation.

ASX200 futures are pointing to a positive start.

Good Morning,

The ASX200 fell -90.1 points or -1% to 8920.80, a 6-week low, as RBA rate hike concerns weighed on sentiment, as well as the ongoing uncertainty around the Iran/US war and the impact on the oil price and inflation.

Consumer Discretionary, Info Tech and Financials led the market lower, with Energy, Healthcare and Utilities positive.

To stay in touch with which companies are going ex-dividend, check out the FNArena Calendar https://fnarena.com/index.php/financial-news/calendar/

Today’s Big Picture, J.L. Bernstein extract

The War Premium Got Sold

Brent touched US$99.46 at the open, a six-week high, then slid back toward US$97.

WTI finished near flat after being up more than a dollar in the morning.

The Houthis hit the Jazan refinery, 400,000 barrels a day that serves Saudi Arabia’s own market rather than the export terminals.

Nothing that leaves the country was damaged, and the market worked that out by lunch.

The Bond Market Did Not Flinch

The 2-year yield sat flat at 4.38 all day. The 10-year moved about two basis points to 4.80 and the 30-year did the same to 5.27.

That is a market saying a refinery fire does not change what happens on September 16.

Traders still put the odds of a rate increase next week near six in ten.

The Cushion Is Thinner Than The Headlines

The Strategic Petroleum Reserve is under 290 million barrels, its lowest level since 1982.

That is why crude still moves hard on a single headline even when actual supply is untouched.

China is doing some of the offsetting work, buying more Persian Gulf crude in August and sending refined product back out to the world.

The buffer is real, it is just sitting in somebody else’s tanks.

ANZ Bank, Australian Morning Focus

Equity markets declined, as geopolitical developments weighed on risk sentiment. Oil prices rose after Saudi Arabia reported operations at several facilities were suspended after Houthi attacks. 

The S&P500 was down -0.6%. In Europe, the EuroStoxx50 was up 0.1% and the FTSE100 was down -0.1%. 

The yield on the 10yr US Treasury note was unchanged at 4.79%. 

In commodities, the active WTI future rose 0.6% to US$94.2/bbl. Gold fell -1.4% to US$4,358/oz.

US: The NFIB Small Business Optimism Index fell -1.1pts to 98.7 in August, though it remained above the long-run average of 98.0. Inflation indicators were unchanged in the month, though remain elevated.

A net 31% of firms reported raising prices in August, while a net 28% planned to increase prices in the next three months. Labour market indicators softened. A net 17% of firms expected to hire in the next three months, down from 20% in July.

Firms’ expectations for the economy also deteriorated. A net 10% of firms expected business conditions to improve in the next six months, down -5pts from July.

US Fed: As markets wait for crucial US inflation reports for August, due later this week, upside inflation risks are intensifying in response to developments in the Middle East. Oil prices have risen nearly 15% in the past fortnight. 

While we think another month of encouraging inflation data would give the FOMC enough confidence to hold rates steady in September, it is an open question as to whether ongoing geopolitical uncertainty will undermine the confidence of policymakers.

Absent a resolution in the Middle East, policymakers may become increasingly concerned about the risk that current inflation uncertainty becomes embedded in expectations. 

The latest NY Fed survey of consumers provided some comfort. 3y-ahead consumer inflation expectations fell -0.1% pt to 3.2% in August, while 5y-ahead expectations were stable at 3.0%, signalling consumer expectations remain well-anchored despite volatility in energy prices.

Industrial metals led the gains on signs of further tightness. Energy was higher on concerns of further supply disruptions in the Middle East.

Global: A higher neutral rate explains some of the bond sell-off, Oxford Economics

The rise in bond yields across the world over the past six months has investors and governments wondering about its causes. One key determinant of bond yields is the real neutral rate of interest, r* – the inflation-adjusted, risk-free rate that would obtain when inflation is at target and the economy operates at potential.

This hypothetical rate isn’t directly observable and must be inferred from data. Estimates based on financial market data have started to rise at the same time as bond yields on both sides of the Atlantic, but estimates based on macro data, which are lagging and more backward-looking, have remained broadly flat.

The average increase in financial r* estimates of 25bps over the past six months isn’t huge, but it’s meaningful because the neutral rate is a slow-moving, persistent variable.

A move in bond yields is more often caused by changing inflation expectations or term premia, which are usually more volatile but haven’t shifted much this year.

What’s the level of r*?

The broad range of estimates from different models shows how difficult it is to estimate the unobservable in real time. But each estimate has some value as it emphasizes a different aspect of the neutral rate.

We extract the information in each series with a dynamic factor model; the estimated common factor can be interpreted as the single r* underlying all those different estimates.

For August, our estimated common factor points to a neutral rate of 1.2% for the US and 0% for the Eurozone, up 10bps from January in each case.

The change isn’t bigger because macro estimates haven’t moved much – they’re relatively stable by construction, based on backward-looking data, and haven’t yet been released in full for Q2.

Given all that, it speaks for the common factor that it has picked up the signal from financial estimates.

Secular forces will push up the neutral rate until 2030

What’s perhaps more important than the change this year is where the neutral rate is heading over the next few years. The macro models cited above can’t answer that because they’re purely backward-looking.

The financial market models, although they’re based on forward-looking yield data, are designed to disentangle the term premium from a constant average neutral rate and, hence, can’t say much about the future r* trajectory.

Our own established structural general equilibrium model overcomes these challenges and is capable of quantifying future shifts in r* caused by structural changes. By feeding in our latest macro forecasts, we found that the neutral rate in the US will rise by 50bps between 2026 and 2031. In the Eurozone, it will rise by 30bps between 2026 and 2029 but then start weakening again.

Compared to January, our new forecasts have shifted up the predicted trajectory of r* by an average of 10bps over the next five years, although this upward shift is more frontloaded for the US and more backloaded for the Eurozone. That’s important because it can help explain the move in bond yields, as they depend on the path of future neutral rates.

The reasons why we expect neutral rates to rise differ by economy. A common driver is total factor productivity (TFP) growth, which we think will mainly be AI-related and which we’ve revised up since January.

After 2029, the boost from productivity is larger for the Eurozone because the bloc is much slower in broadly and efficiently adopting AI than the US.

For the US, the rise in government debt is another important driver, but not because of fears of default. Rather, the risk-free neutral rate goes up because investors need to be incentivised to hold more government debt than they already do.

To the extent that there are fiscal risks, those would be reflected in an additional default risk premium on top, but we don’t think fiscal risk is part of the current story.

The third main driver in the US is net international capital flows, which we think will reverse, partly due to the impact of tariffs. The ‘global savings glut’ that helped keep US rates down for decades isn’t completely going away but weakening as the US imports fewer goods and, hence, less capital.

The picture in the Eurozone looks quite different. Apart from the back-loaded TFP impact, the bloc’s neutral rate benefits from increases in statutory retirement ages that will come into effect in a range of member countries over the next few years, mitigating the secular headwinds from an ageing population.

To understand how ageing matters, let’s consider a capital markets framework where r* equilibrates the aggregate supply of and aggregate demand for capital. Higher life expectancy makes people save more for retirement, which raises aggregate savings – i.e., the supply of capital.

All else equal, that depresses the neutral rate. A rising retirement age mitigates and delays this effect.

The new EU and German infrastructure and military spending will have only a small upward impact as EU government debt is limited by the bloc’s fiscal rules in the longer run.

What this means for governments and investors

There’s substantial uncertainty about the level and direction of rates. Treasury Secretary Bessent thinks that markets are wrong and long-term government bond yields are too high.

To back up his view, he has announced an expansion of the Treasury’s debt buyback program, known as operation ‘Treasury Twist’.

While the additional buyback of longer-dated securities in exchange for short-dated bills is probably too small to make much of a dent by itself, Bessent hopes the signal and the information will change investors’ minds.

Truth be told, the Treasury may also have other goals in mind, such as to manage the cost of debt. US government debt is projected to rise sharply and the cost of servicing it will rise, too.

On top of that, government bonds must compete for investors’ funds with other attractive investments, for example, AI-related corporate debt issuance, which currently is only a drop in the ocean but could become much larger over the next few years.

These macro trends may make it difficult to lower yields permanently, at least at the long end.

But as our colleagues at Alpine Macro have argued, bond hysteria isn’t justified. Neither the fiscal risk premium nor the term premium looks unduly high. The bond market is simply normalising after two decades of abnormally low interest rates, opening up attractive investment opportunities.

Finally, our results support our view that market pricing reflects expectations of a more hawkish – or at least less dovish – path for central banks.

The neutral rate is, after all, the terminal rate that policy rates should eventually converge to.

Corporate news in Australia:

• Corporate Travel Management ((CTD)) founder and former CEO Jamie Pherous has increased his stake in the company following an -86% collapse in the share price
• Ghanda founder Josh Rudd has acquired a 6.18% stake in KMD Brands ((KMD)) as the Kathmandu and Rip Curl owner continues to attract takeover interest
• Brookfield is seeking investment committee approval to progress its potential acquisition of Colonial First State from KKR and Commonwealth Bank ((CBA)), with the wealth manager valued at more than $5bn and final due diligence expected to follow
• Sembcorp has launched a process to sell a stake in Alinta Energy’s planned $1.5bn-plus, 550MW Marri wind farm in Western Australia
• Cricket Australia has cleared state associations to sell substantial stakes in Big Bash League teams to private investors, opening the way for franchise transactions including a planned sale of the Melbourne Renegades
• Warburg Pincus has emerged as the frontrunner in the circa $1bn auction for Apax-owned Pickles Auctions, ahead of private equity rivals PEP, EQT and Blackstone
• KKR is preparing a potential $3bn-plus sale of Arnott’s, with an investment banking adviser expected to be appointed within weeks and Mondelez identified as a potential strategic buyer
• Firmus is preparing to restart IPO discussions with investors after securing OpenAI as an anchor customer, while shifting a greater proportion of its AI infrastructure expansion from Australia to Malaysia

On the calendar today:

-CH Aug PPI & CPI

-BHAGWAN MARINE LIMITED ((BWN)) ex-div 0.30c (100%)

-BRAMBLES LIMITED ((BXB)) ex-div 32.82c (20%)

-CSL LIMITED ((CSL)) ex-div 227.70c

-EVOLUTION MINING LIMITED ((EVN)) ex-div 21.00c (100%)

-EVT LIMITED ((EVT)) ex-div 23.00c (100%)

-GENESIS MINERALS LIMITED ((GMD)) ex-div 5.00c (100%)

-HEARTS AND MINDS INVESTMENTS LIMITED ((HM1)) ex-div 10.00c (100%)

-IDP EDUCATION LIMITED ((IEL)) ex-div 6.00c

-IVE GROUP LIMITED ((IGL)) ex-div 9.00c (100%)

-IGO LIMITED ((IGO)) ex-div 5.00c (100%)

-LGI LIMITED ((LGI)) ex-div 1.35c (100%)

-NORTHERN STAR RESOURCES LIMITED ((NST)) ex-div 30.00c (100%)

-NETWEALTH GROUP LIMITED ((NWL)) ex-div 21.00c (100%)

-SUMMERSET GROUP HOLDINGS LIMITED ((SNZ)) ex-div 2.68c

FNArena’s four-weekly calendar: https://fnarena.com/index.php/financial-news/calendar/

The Australian share market over the past thirty days…

For more detail go to FNArena’s Australian Broker Call Report, which is updated each morning, Mon-Fri.

All overnight and intraday prices, average prices, currency conversions and charts for stock indices, currencies, commodities, bonds, VIX and more available on the FNArena website.  Click here. (Subscribers can access prices on the website.)

(Readers should note that all commentary, observations, names and calculations are provided for informative and educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views expressed are the author’s and not by association FNArena’s – see disclaimer on the website)

All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts on the website and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided. www.fnarena.com

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms