Saudi-Israel Treaty Nears

Welcome back to SovereignBeat!

In this publication:

• No hikes, but no cuts either from Powell and Co

• EU set to cut rates on June 6th, diverging from the Fed

• Strong US jobs report lifts all key asset classes

• Commodity prices steady in 2024, but wheat expected to tumble 15%

• US, Israel and Saudi Arabia Nearing Historic Pact

Let’s dissect

Markets Snapshot

Bond Markets

• US: For the sixth consecutive time, the Fed maintained the federal funds rate target range at 5.25%-5.50%, citing persistent inflationary pressures and a tight labor market. Following Wednesday's meeting, the Federal Open Market Committee headed by Jerome Powell expressed the view that there had been "a lack of further progress" towards its 2 percent goal in recent months. This effectively postpones rate cuts until the second half of this year at the earliest.

• Powell also indicated that Fed bankers remain confident that the current policy rate is exerting sufficient pressure on economic activity to curb inflation and they are willing to wait as long as necessary for that to become apparent, even if inflation is simply "moving sideways" in the meantime . This implies that the rate hikes that have concerned markets in recent weeks are essentially off the table.

• Additionally, starting from June 1st, the Fed intends to reduce its quantitative tightening (QT), decreasing the monthly reduction of Treasury securities from USD 60 billion to USD 25 billion. However, mortgage-backed securities will continue to mature by up to $35 billion monthly.

• After expanding the balance sheet to approximately $9 trillion from its pre-pandemic level as part of its quantitative easing program, the Fed has begun allowing some of its holdings of Treasuries and mortgage-backed securities to mature without reinvesting the funds into new ones. This process, initiated in the latter half of 2022, has led to a reduction in the Fed's balance sheet to $7.5 trillion. The current reduction in QT is intended to prevent the financial system from experiencing a shortage of reserves, albeit we expect it to create more loose financial conditions at the margin. More significantly, the Fed's action suggests that they are prepared to absorb the Treasury bond issuances scheduled over the coming quarters to meet the increasing demand for the government deficit spending.

• On Friday, the 10-year Treasury yield fell sharply, closing the trading week at 4.66%, in response to a weaker-than-expected jobs report. Both payroll gains and wage growth decelerated, reinforcing Chair Powell's stance on Wednesday that the Federal Reserve is not inclined to raise rates, despite the ongoing lack of substantial progress in inflation this year.

• EU: In Q1 2024, the eurozone emerged from a shallow recession with a 0.3% GDP growth, propelled by improved performance in its four largest economies. After contracting by 0.1 percent in the previous two quarters and growing by only 0.1 percent in the quarter before that, the eurozone's output increased by only 0.4 percent year-on-year. This quarter's growth, albeit low, represents the fastest expansion in eighteen months.

• Meanwhile, April's inflation rate in the euro area held steady at 2.4%, consistent with March's rate and in line with expectations. Services inflation, which has been a primary concern for the ECB in recent months, eased for the first time this year to 3.7 percent. ECB Governing Council member Francois Villeroy de Galhau noted that this stable inflation provides room for the ECB to contemplate rate cuts in June. His colleague, ECB Governing Council member Yannis Stournaras, hinted that the ECB might slash interest rates three times this year, down from an earlier forecast of four, as inflation meets expectations.

Equity Markets

• Despite the uncertainty in the current economic landscape, Powell's portrayal of rate hikes as unlikely brought confidence to equity investors worried about more hawkish stance from the Fed. On Friday, this belief was reinforced by a weaker jobs report, propelling U.S. equity markets to increase over 1% for the day. The Nasdaq notably exhibited even stronger performance than other indices, closing nearly 3.5% higher for the week. Bizarre times we live in: the addition of fewer jobs to the economy is perceived as a positive event in the eyes of equity investors.

Commodity Markets

• WB Commodity Outlook: Global commodity prices are stabilizing after a sharp decline, which significantly contributed to reducing overall inflation last year. This stabilization could pose challenges for central banks seeking to swiftly cut interest rates according to the World Bank’s latest Commodity Markets Outlook for April.

• Prices of copper—essential material for electricity-grid infrastructure and electric vehicles— expect to rise 5% in 2024 before stabilizing in 2025. Prices of aluminum are forecasted to rise by 2% in 2024 and 4% in 2025, bolstered in particular by the production of electric vehicles, solar panels, and other renewable-power infrastructure.

• WB projects global food prices to decline by 6% in 2024, followed by an additional 4% decrease in 2025. To be more specific, wheat prices are forecasted to drop by 15% in 2024, with a further 2% decrease in 2025, influenced by elevated production levels and the lowest stocks-to-use ratio in eight years. Nonetheless, the upside risks for food prices remain elevated. Middle East region continues to serve as a critical gas supplier, with 20% of global liquefied natural gas (LNG) trade passing through the Strait of Hormuz. Any disruption to LNG supply could lead to a significant increase in fertilizer prices, thereby likely driving up food prices as well.

• Oil: Oil prices settled at 82.8 on Friday, marking a more than 6% weekly decline, the highest in the last three months, as investors assessed weak U.S. jobs data. Additionally, US crude inventories surged to their highest levels since last June, sparking concerns of an impending supply glut and further contributing to the decline in prices. The Energy Information Administration reported that US crude inventories had surged by 7.3 million barrels to 460.9 million barrels in the week ending April 26, reaching their highest level in 10 months.

Geopolitics

Saudi-Israel Relations Plan Orchestrated by the US

• The US and Saudi Arabia are reportedly close to a groundbreaking pact, offering the kingdom security assurances and potentially paving the way for diplomatic relations with Israel. This agreement would represent a revised framework previously disrupted by the Israel-Hamas conflict.

• The potential deal would involve Saudi Arabia formally recognizing and establishing diplomatic relations with Israel, while Israel would commit to significant measures toward the creation of a Palestinian state. As part of the agreement, the US would provide security assurances to Saudi Arabia while potentially supporting the development of a civilian nuclear program, a longstanding economic goal for the country.

• Last September, Israeili Prime Minister Netanyahu already announced in a speech at the United Nations that his country was “at the cusp” of a “historic peace” with Saudi Arabiai, but the elusive deal stalled after October 7.

Our thoughts

• The deal could be groundbreaking as, since Israel's founding in 1948, Saudi Arabia has consistently rejected recognition of the Jewish state. In our view, given the current challenges with ongoing Gaza conflict, brokering an agreement between Israel and Saudi Arabia may be the one of the few available avenues to pave the way for peace in the region.

• For the Biden administration, this presents an opportunity to build upon the historic Abraham Accords brokered by the Trump administration, further advancing recognition of Israel by Arab countries.

• Speaking of risks, we echo the perspective of numerous experts and geopolitical analysts that the "civilian nuclear program" backed by the US could, unfortunately, quickly evolve into a weapons program.

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Our Further Reading Recommendations

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