Iranian drone strike on Israel escalates Middle East tensions

In focus today

The key focus today will be the escalation of the Middle Eastern conflict following the Iranian strike on Israel and signals on the extent of Israeli retaliation, see more below.

In the euro area, we receive industrial production data for February. The industry has been weak the past years, but we are currently receiving tentative signs of a bottoming out of activity. German industrial production rose 2.1% in February, so we could be in for a decent monthly increase in the euro area today.

In the US, focus will be on March retail sales. Control group sales are likely to recover after weak prints in January and February. Unusually low seasonal adjustment factor weighed on sales growth at the start of the year, but the effect will fade from March. Besides technicalities, higher oil prices, recent upticks in immigration and the early timing of Easter may have all lifted sales towards spring. 

In Sweden, the government presents its Spring Fiscal Policy Bill and amending budget bill for the current budget year. As the government already announced that the additional reforms will amount to only SEK 16.8bn it is fair to say that they maintain their restrictive fiscal policy. The number of additional reforms can be set into comparison of a SEK 33bn better than expected central government budget outcome of the last two months, or the fact that it amounts to only roughly 0.3% of the current Swedish GDP.

Overnight China will release GDP for Q1 on top of the monthly data dump across sectors. GDP is expected to rise 4.9% y/y in Q1 down from 5.2% y/y in Q4. However, it reflects a tough comparison with the high Q1 level last year after the covid reopening. On a q/q basis we look for around 1.5% growth corresponding to 6% annualised growth. Focus will also be on the data on retail sales and home sales. Consumers may hold back a bit on spending now after signals from the government that a trade-in scheme is coming, where people can trade in old durable goods and get a discount on new goods. Home sales and housing prices will provide key information on the state of the housing crisis. 

Later in the week, focus will be on German ZEW data for April (Tuesday), final euro area inflation for March (Wednesday), and nation-wide March CPI from Japan (early Friday).

Economic and market news

What happened over the weekend

Tensions in the Middle East escalated as Iran attacked Israel with drones and missiles Saturday night, in retaliation for the alleged Israeli killing of military personnel at the Syrian embassy of Iran earlier this month. Damage was modest as the IDF reported to have shot down most of the weaponry. The attack was to some extent anticipated as Iran had vowed to retaliate, but both the US and several regional powers had urged restraint. The market reaction has so far been somewhat muted as markets weigh the probability of further escalation, though gold was slightly up this morning and oil slightly down. Iran says it considers 'the matter concluded' but could use greater force if Israel responds in kind while the Israeli war cabinet said on Sunday it was 'unclear when and how big' the response should be, FT reports. The US has urged Israel to show restraint. Iran has previously threatened it could close the Strait of Hormuz, through which 20% of the volume of the world's oil consumption passes through as well as a significant share of gas.

China kept a key policy rate unchanged, even after Chinese credit data surprised to the soft side on Friday suggesting China is still 'muddling through' with no bust but no strong recovery either. Despite this, the MLF rate remained unchanged on Monday as there has been pressure on the Chinese currency lately due to expectations of higher US rates for longer. Going forward, we think the PBOC stays put for a while and waits for clearer signals that the Fed is cutting as it gives them more space to lower rates without adding depreciation pressure on the currency.

In an effort to reduce Russian metals' production revenue, the US and UK expanded sanctions by banning aluminium, copper and nickel produced by Russia from being imported to the two countries, as well as banning metal exchanges (LME and CME) from accepting new contracts trading Russian-produced metals.

What happened Friday

EUR/USD continued to decline during the day as the ECB has indicated rate cuts are near while recent upside US macro surprises have lowered market expectations of rate cuts from the Fed, the latest example of this being the University of Michigan consumer sentiment showing both 1Y and 5Y inflation expectations have risen with the former showing 3.1% (+0.2).

Swedish inflation surprised to the downside with the CPIF printing at 2.2% y/y (cons: 2.6%) and core at 2.9% (cons: 3.2%) which gave further merit to a May rate cut from the Riksbank, for which markets are currently pricing 20bp. The SEK was initially weaker, then erased some losses but closed weaker with EUR/SEK up 0.68%.

Equities: Global equities were lower on Friday and lower for the week, dragged down by the US. Despite the leg lower in equities cyclicals still outperformed last week, which shows how equity investors are more nervous for overheating than recession. On Friday we saw big banks in the US massively underperforming led by JPM as their earnings and not least guidance failed to impress. In the US on Friday Dow -1.2%, S&P 500 -1.5%, Nasdaq -1.6% and Russell 2000 -1.9%. Asian markets are mostly lower this morning following Friday session on Wall Street. US and European futures are higher which might be slightly surprising for some given the Iranian attack on Israel.

FI: There was a solid decline in primary European government bond yields on Friday, where the Bund rallied some 10bp and US 10Y Treasuries rallied 6bp after the negative sentiment had dominated the bond market after the higher-than-expected US CPI-data released earlier last week. Initially, the decline in the was bigger, but at the end of the day there was a minor rebound in bond yields. If we look at the 10Y BTPS-Bund spread the spread has widened since mid-March but has now stabilised around 130bp. Furthermore, the Bund ASW-spread has also stabilised and is now trading above 30bp.

FX: The Iranian attack on Israel and raised tensions in the Middle East have weighed on Asian equities and the JPY. Muted response in oil so far with Brent at just above USD 90/bbl. EUR/USD tumbled more than 2% last week following the US CPI and the ECB news but is stable around 1.065 this morning. EUR/SEK starts the week around 11.56 and EUR/NOK 11.58, both with their eyes on the next leg for risk sentiment and oil.