Comparisons To 1987 Are Multiplying

By Benjamin Picton, Senior Macro Strategist at Rabobank

Political Pickers

Equity markets closed broadly higher yesterday and bond yields rose to retrace some of the falls over two days of financial bloodletting induced by a lacklustre jobs report and the unwinding of speculative Yen carry trades. The S&P500 added 1.04%, the NASDAQ 1.03% and the Nikkei went limit-up to rise 10.23% after triggering circuit breakers on its way to a 12.40% loss the day before. Europe missed out, with the EuroStoxx 50 and the DAX little changed, the FTSE up smalls and the CAC 40 posting small losses.

The US yield curve bear steepened over the course of yesterday as 2-year yields rose 5.5bps and 10’s added 10.3bps. The JPY has weakened in early trade this morning to 146.50 after BOJ Deputy Governor Uchida appeared to capitulate to markets, suggesting that the BOJ won’t raise rates while financial markets are volatile. Considering that the volatility only arrived after the BOJ raised rates, that reads as a bit of a platitude.

Comparisons have been made between the price action over the last few days and the Black Monday crash of October 1987. That might be a little overblown given the relatively modest percentage falls this time around, but the sharp fall followed by a sharp recovery does look similar in some ways. Both occurred while equities looked richly-valued after a stellar bull run, both occurred while US fiscal deficits were running high, both occurred after a Fed tightening cycle, and both occurred as the Dollar was being pressured lower against other currencies.

The 1987 crash is sometimes pointed to as a precursor to the early 1990s recession in the United States. That recession followed a period of tight monetary policy and was characterized by a banking crisis and oversupply in office real estate. Sound familiar?

Another comparison to the early 1990s that we might draw is (potential) generational change in Washington. A youthful Bill Clinton famously rode economic discontent to victory in the 1992 election, defeating 68-year old George H.W. Bush whose run was stymied to some degree by a third party candidate. Does that sound familiar?

Yesterday Kamala Harris announced she has selected Minnesota Governor Tim Walz as her VP pick. Walz is seen as a safe pair of hands who will hold some appeal in battleground states. He is a former schoolteacher who served as a non-commissioned officer in the US army before being elected to US Congress and eventually the Minnesota Governor’s mansion, but he also has a progressive legislative record that will appeal to the Democratic base.

Walz beat out Pennsylvania Governor Josh Shapiro for the VP spot. Shapiro was considered the favourite by many due to his potential to broaden the electoral coalition, his strong personal popularity and his position as the Governor of a crucial swing state (unlike Walz). Republicans, some media outlets and even some Democrats have suggested that Shapiro’s status as an observant Jew and staunch defender of Israel may have ruled him out of the race due to his unpalatability with the Democrat’s pro-Palestinian base.

Walz wasn’t the only political appointment of note yesterday. Hamas announced that Yahya Sinwar, the architect of the October 7 attacks, will succeed Ismail Haniyeh as the group’s political leader after the latter was assassinated in Tehran last week. Sinwar’s appointment comes ahead of expected attacks from Iran and the ‘Axis of Resistance’ against Israel in retaliation for the death of Haniyeh. US and Israeli intelligence suggests that those attacks are imminent, and many foreign governments have advised their citizens to leave Lebanon and Iran in anticipation.

We are still waiting for that particular shoe to drop, but with Brent crude down to $76.50/bbl this morning there may be a ‘boy who cried wolf’ element at play where financial markets have become desensitised to supply side risks in the Middle East, and are focused instead on signs of softening demand in the United States and China.

While none of the belligerents appear to relish the prospect of war, all of them have expressed a willingness to fight if red lines are crossed. Benjamin Netanyahu said last week that “Israel will exact a very heavy price for aggression against us” and the elevation of Sinwar serves as further confirmation that rapprochement is near impossible.

So, the only questions now are when does the blow come, how hard does it fall, and what will be Israel’s response?