As Last week’s trading session coincided with a sudden but moderate correction in the major global stock market indices, a drag clearly linked to the ongoing geopolitical uncertainty in the Middle East, which sellers used to justify the partial realization of profits accrued in the aftermath of the unilateral US declaration of cessation of the conflict with Iran.
It should be remembered that the recent index highs reflect the stock market’s belief that the conflict is over and that both energy prices and logistics activities will gradually return to normal, albeit at higher prices and costs than before the hostilities. In essence, we are witnessing a sort of last gasp of the Third Gulf War, during which all players are seeking to gain further progress, even if marginal, but which can be used to their advantage in the now inevitable and imminent diplomatic agreement. In the case of Israel, the situation is much more complicated because the regional military activity following the dramatic terrorist attack of October 7, 2023, would be aimed at permanently eradicating the threat of decades-long Iranian aggression, a goal that would be missed if an imminent truce were to be reached. The timing of this truce is of considerable importance in defining the global economic outlook, which is entirely dependent on energy price dynamics and the logistics costs of international trade.
If, as is hoped, a truce agreement between the US, Israel, and Iran is reached soon, then the positive macroeconomic scenarios forecast at the beginning of the year could be achieved with modest adjustments. This hypothesis is supported by recently released indicators in the US, where the economy continues to progress, as evidenced by employment data consistent with 2.5% GDP growth in the second quarter.
This data has led many industry insiders to believe that the Fed might raise its key rate well before the end of the year, but two considerations make this unlikely. First, the Fed historically does not change its rate in the six months preceding an election, with the recent exception of Mr. Powell before the last presidential election. Second, the new Governor, Mr. Warsh, appears to favor a trend inflation index, the Dallas Fed, which is based on a variable basket of goods and is closer to the 2.0% target. The ECB’s decision to raise its key interest rate by a quarter of a percentage point, however, could prove ill-advised. It runs the risk of making the same mistake it made in 2022 with the outbreak of war in Ukraine: that of encouraging a worsening of the economy by repeatedly raising interest rates in an anti-inflationary manner.
This inflationary pressure, if any, is caused solely by the cost component, without increasing demand. Therefore, this component should be addressed directly, for example by reducing its tax burden, without jeopardizing the economic outlook for the economy as a whole.
Nicola Bravetti Data source: Bloomberg
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