Middle East caution continues to grip investors

U.S. stocks bounced off geopolitical-driven lows, finding under-the-hood support in the ADP jobs report. However, with tensions in the Middle East still bubbling, U.S. port workers on strike, and global industrial giants battling economic headwinds, the last quarter of 2024 is starting to look much more turbulent than the relatively smooth sailing we saw in the first three quarters. It suggests that, at minimum, investors might remain on the sidelines until the geopolitical storm clears.

The fourth quarter had barely kicked off before the looming threat of a direct Israel-Iran standoff rattled investor confidence. Markets saw a flurry of activity as traders scrambled to hedge, especially in oil, which is always the go-to "Middle East tinderbox hedge."

The ADP report delivered a bright spot for those rooting for a soft landing. Despite a rise in labour demand, wage growth slowed, giving the Fed some breathing room. The Fed can afford to look past the heady print as long as wages stay in check—and this report suggests they will. With inflation continuing to cool, the stage is set for the Fed to keep rolling out those "insurance" rate cuts.

Simply put, as long as wages don’t take off again, the Fed, determined to cut rates, can press ahead even in the face of steady. This falls neatly into the ongoing theme of the Fed positioning itself to safeguard against an ever-widening array of economic risks.

Still, Friday’s nonfarm payrolls report will have the final say, which could serve as a reality check on the U.S. economy. Economists are pencilling in around 146,000 new jobs for September. If the data sticks close to that estimate (barring any significant revisions), the three-month average for non-farm payrolls would be 126,000, notably below what's needed to maintain job replacement levels.

The Fed’s job isn’t to sweat slight, incremental upticks in job growth, especially if inflation is hovering around the target or easing toward it. Right now, real rates are too high, making the economy more fragile than it needs to be. The smart move? Lower rates. Steady job numbers might argue for a more gradual approach, like 1/4% cuts per meeting. Iterative adjustments are typically the name of the game unless something's really off the rails —whether it’s a recessionary slight or a major financial/credit crisis.

In the FX market, USD/JPY traders seem to have caught on that while the Fed is cutting rates to navigate an ever-growing list of economic risks, the latest signals from the Bank of Japan suggest they’re in no hurry to hike rates amidst the global uncertainty. With economic data looking scattergun and hard to interpret worldwide, the last thing Japan seems keen to do is tighten monetary policy. Domestically, they’ll need solid proof that the economy can handle a stronger yen without triggering major stock market losses or harming exporters, especially when global consumer confidence is scraping the bottom of the barrel.