By Anna Szymanski
Oct 9 (Reuters) - Could bond market pain be contagious? Volatile oil prices, rising political risk in Europe, more Middle East fighting, and news of another round of mammoth AI corporate borrowing kept tensions in the sovereign debt market as taut as ever this week.
The question is whether equity markets can remain immune.
Let's start in Europe, which was at the heart of bond market concerns for much of the week. The spread between French and German 10-year debt blew out beyond 140
basis points, the widest since 2012, as investors increasingly offloaded the debt of the bloc's most indebted countries and sought safety in stalwarts like German Bunds.
The French government is seeking to tackle its debt woes with a 2027 budget that aims to lower the country's deficit to 5% from an expected 5.4% this year. But getting that budget over the finish line ahead of next year's presidential election will be challenging given the deeply divided parliament and the widespread protests the country has experienced over insufficient education funding and other matters.
France is far from the only European country facing a fractious political landscape. Spanish Prime Minister Pedro Sanchez on Monday called a snap election for November 29 that he hopes will give him a parliamentary majority. But it's a gamble as the centre-left bloc trails in most opinion polls.
All this political risk and bond market stress has pummelled the euro. The currency hit a 17-month low of $1.1161 on Monday before recovering slightly.
The backdrop is creating a challenging environment for the European Central Bank. Markets still anticipate another hike by year-end, given that euro zone inflation remains stubbornly high around 3.8%, but policymakers may seek to be cautious given the bond market tremors.
Elevated energy prices certainly aren't making the ECB's job any easier.
While crude prices dipped early in the week – largely due to reports that oil flows out of the Gulf were nearing pre-Iran war levels – that optimism faded quickly. Brent crude prices jumped 4% on Thursday to over $104 a barrel amid intensified Iranian strikes on ships in the Strait of Hormuz, as well as attacks in Saudi Arabia by Yemen's Iran-aligned Houthis.
However, crude gave back some of these gains on Friday after President Donald Trump said on Thursday that the US would not attack Iran before the midterm elections. Brent is still on track to post a weekly increase.
Amid all this geopolitical noise, there was only a limited positive reaction to Wednesday's news that the International Energy Agency had agreed to accelerate the release of oil, prioritizing diesel, as part of a plan launched in March intended to tackle record-high fuel prices.
This reaction may reflect the new energy market reality: fuel prices could remain elevated even if crude exports out of the Gulf remain near pre-conflict levels or pick up globally. That's because of the hefty geopolitical risk premium and the complicated – and very expensive – logistics involved in getting oil out of the Middle East.
Another matter affecting energy prices this week concerns an entirely different gulf. Hurricane Isaias has already disrupted oil and gas production in the Gulf of Mexico and is heading toward the US Gulf Coast.
Staying in the US, let's head back to bond markets. Expectations for a Federal Reserve rate hike in October fell sharply last week amid soft economic data and less hawkish signalling from New York Fed President John Williams. But the minutes from the September FOMC meeting released on Wednesday, and comments from Fed Governor Christopher Waller on Thursday, suggest that the central bank is certainly not done tightening – even if policymakers do sit on their hands this month.
The real action, of course, was in the longer end of the curve. The benchmark 10-year Treasury yield rose this week to a fresh 24-year high, briefly hitting 5.364% on Wednesday. It eased slightly on Thursday, however, after strong demand at a 30-year bond auction – though the debt reportedly cleared at the highest yield since 2000.
For much of this week, it looked like even +5% yields and rising energy prices weren't enough to stop equities. The Nasdaq and S&P 500 both hit new record highs on Tuesday. However, they eased a bit late in the week as crude prices rose. Chip stocks also came under pressure after reports that OpenAI's annualized revenue for September was $20 billion below the company's previous indications.
This brings us back to the ever-present debate: Is the AI surge about to slump?
This will be top-of-mind as the third-quarter reporting season kicks off. While no analysts anticipate the eye-popping 50% earnings growth we saw last quarter, the latest LSEG data show expectations of roughly 30%.
Early action this earnings season suggests tech firms may struggle to impress investors. On Thursday, Samsung Electronics and TSMC both saw their shares slip, even as the South Korean tech firm projected a 783% jump in third-quarter operating profit and the chip giant reported record-high third-quarter revenue.
One looming concern for investors is the latest corporate debt binge. According to the Wall Street Journal, Broadcom is seeking to raise $50 billion in financing, while SpaceX is planning to issue $30 billion in investment-grade debt and raise $10 billion in loans to buy chips from Nvidia, a major SpaceX shareholder.
So is Thursday's modest slump in equities a sign of an inflection point or yet another minor speed bump? While stock markets have mostly ignored the spike in yields this year, history suggests that this is unlikely to continue for long. The question, as ever, is how "long" that may be.
Finally, in emerging markets, Brazilian assets logged historic gains on Monday after right-wing candidate Flavio Bolsonaro's stronger-than-expected showing in the first round of voting in the country’s presidential election. He is now the favorite to win the second round on October 25. Meanwhile, in India, the central bank raised its benchmark repo rate by 25 basis points to 5.5% on Wednesday, the first rise in nearly four years, driven by mounting inflation.
Looking to next week, earnings season really gets going with a host of reports from big US banks, while investors – and the Fed – will get more inflation data with the release of September CPI on Wednesday.
Before you head off, take a look at some questions ROI columnists have recently been exploring:
• Will AI labs ever be able to turn a profit?
• Should we start thinking about "S&P 10,000"?
• Why might a potential ECB leadership change be bad news for France?
• Will central banks be good cops or bond villains?
• How did renewables help keep the lights on in the US this summer?
• Could Europe's electoral calendar be the death knell for its economic reform push?
• Will the China-India diplomatic thaw lead to larger economic shifts?
• Why isn't the price of tin falling back to earth?
• Which country could take advantage of China's pullback in fuel exports?
• What tectonic shift is occurring in the zinc market?
• Could coal shipments stage a fourth-quarter rebound?
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