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The week has seen hopes fading for a near-term resolution to the conflict in the Middle East. Risk appetite has also been under pressure from rising inflation and fiscal concerns, particularly in France, resulting in bond yields pushing higher once again. The selloff has intensified in recent weeks thanks to surging fuel prices and strong US economic data boosting expectations the Federal Reserve will hike rates at their October meeting. That said, market pricing for an October hike has actually fallen back significantly this week to a 27% probability per Bloomberg, helped by in-line inflation data and comments from the New York Federal Reserve’s John Williams, who said “there is no need for urgency” in the aftermath of the September rate hike.
The French government revealed plans to cut the budget deficit by restraining spending and raising tax revenues. The final budget before the 2027 presidential election saw ministers present €43 billion of measures to cut the fiscal deficit from 5.4% of GDP this year to 5% in 2027. This would be the fifth consecutive year the deficit has been over 5% and well over the 3% limit set by the European Commission. The last time France had a fiscal surplus was before the 1973 oil crisis. Combined with recent policy measures, the total amount of measures will be €54 billion. Debt servicing costs in 2027 are expected to be €91 billion. The government said there would be no increase in general taxation, though over a third of the €43 billion package is from increased revenue. Cuts to pensions, welfare, state-funded sick leave and public sector wages are likely to face strong opposition and a huge challenge for Prime Minister Sebastien Lecornu’s minority government. The government can force the budget through, but such a move would likely increase the prospect of a no-confidence vote.
The Iranian proposal to reopen the Strait of Hormuz to commercial shipping “within a week” was rejected by the US. Last Friday Iran’s foreign minister Abbas Araghchi told reporters at the UN in New York that an agreement could be reached “if the necessary conditions are met” and these were contained in the Memorandum of Understanding signed by both countries in June. Despite rejecting Iran’s proposals, President Trump said he expected negotiations to resume. Both Iran and the US have cast doubt that a resolution will be reached before the US midterm elections at the start of next month. Oil continued to trade above $100, furthering the ‘higher for longer’ theme that is reflected in oil futures for December 2027 pricing at new highs, of above $80/barrel, this week.
China’s State Council issued a statement signalling it will move with greater urgency to boost economic activity, with the government promising new measures to support the economy and study policies aimed at stabilising the property market. The State Council, chaired by Chinese Premier Li Qiang, said it will “put in place a package of practical and effective additional policies” to “strengthen counter-cyclical adjustments” to achieve this year’s economic and social development goals. China’s Q2 growth was 4.3%, below the annual target of 4.5-5%.
By the numbers
The US Federal Reserve’s preferred measure of inflation came in lower than expected but still above target. The PCE price index rose by 3.4% year-on-year in August, easing from 3.7% in July. Core PCE eased to 3% vs 3.3% expected. More encouraging was the recent data – the annualised figure for the last three months showed an easing close to 2%.
Eurozone inflation continues to rise, boosted by the jump in energy prices. Flash eurozone inflation data for September showed prices rising at 3.8% year on year, up from 3.2% in August and higher than expected. Spanish inflation for September climbed to 5% from 4.6% in August while in Italy CPI rose to 4.2% from 3.3%. German CPI climbed to 3.3% from 2.9% in August, and in France CPI climbed to 3.4% from 2.6%.
Market Movers
An oil price that has become stuck above $100/barrel continues to dominate the headlines, though this does not tell the whole story given the actual inflationary impulse comes from refined products, such as diesel and gasoline. US diesel prices have eased very slightly from last week’s levels but remain up around 70% year to date, and the impact of energy prices was clear to see in the eurozone inflation data published this week. The US national average for diesel is now $6.38/gallon; on the same basis the UK diesel price is $10.05/gallon and in France, $8.99/gallon. News on the supply of crude oil remains mixed and depends on hard-to-analyse data on ‘stealth’ ship movements. All the same, JP Morgan published analysis this week suggesting that shipments of crude oil from the Middle East are now at 98% of pre-war levels (17.5 million barrels/day) despite the ongoing disruption to shipping in the region. Shipments of refined products such as diesel and gasoline are around 3 million barrels/day – a figure that is only around 58% of pre-war levels. Goldman Sachs also updated their data, estimating that oil exports from the Middle East last week were in line with the 2025 average of around 23.5 million barrels/day. These numbers include ‘dark flows’. Goldman’s research suggested that the oil market is ‘in balance’, though Societe Generale still see a deficit of 4 million barrels/day – the shortfall being made up by drawing down on inventories. Soc Gen highlights that the key issue is not crude oil availability but that of refined products, particularly diesel. US refineries are also being operated at full capacity, which tends to result in higher levels of unplanned shutdowns and maintenance due to operational stress. Meanwhile, refineries across the Middle East and in Russia are offline. There was positive news from Saudi Arabia, which stated the East-West pipeline has had 50% of its capacity restored, and from the US, who announced a further release of 40 million barrels from the Strategic Petroleum Reserve. It remains difficult to get a clear overall picture, but it would seem that the real stress is showing in refined products and commodities other than crude oil, such as liquefied natural gas. What we’re watching out for now is any further moves towards a diesel export ban by the US, which would exacerbate pricing pressures in Europe and Latin America, and equally cause significant disruption for US exporters whose production is based around exports and cannot be redirected domestically.
The Investment Lens
This week’s Asset Allocation meeting focused on the backdrop and prospects as we move into the final quarter of the year. Despite ongoing geopolitical headwinds, the economic backdrop remains supportive. Business surveys point to positive and relatively stable economic growth, while the growth in corporate earnings and profits, which has been a key driver in helping markets through what could have been a much more difficult environment, appears set to continue. The breadth of earnings is also encouraging, pointing to strong growth beyond sectors that have been driven along by the AI theme and associated capital expenditure.
Looking forwards, challenges remain. With bond yields pushing higher, and interest rates expected to rise further, equities face a challenge from potential returns elsewhere. That said, market pricing for interest rates continues to shift and the correlation between the oil price and bond yields is high, suggesting that if we do see positive progress in the Middle East, inflation expectations and bond yields will ease. But there is clearly a risk of both sides in the conflict looking to play the ‘long game’, with potentially significant collateral damage across energy markets and the wider economy.
Our views remain constructive all the same. While monetary policy has been tightened in several developed markets, policy is not ‘restrictive’ and underlying economies should be able to handle somewhat tighter policy. With the strength of earnings growth seen in 2026 expected to extend into 2027, we continue to believe the most appropriate use of the risk budget is through equities provided we do not see central banks become more aggressive in their policy stance.
