Dow and Nasdaq slid on Israel-Gaza land invasion uncertainty

On Thursday, Wall Street Futures and gold were initially boosted by Powell’s less hawkish comments, indicating the Fed tightening pause at the current repo rate +5.50% without any rate cut till at least H1CY24; i.e. higher for longer policy. Fed is going for a pause in November and December with a hawkish stance to keep financial conditions tighter enough to bring inflation back to target. But this Fed stance is already known by the market.  And thus the overall boost to risk trade was quite limited.

Again Wall Street Futures stumbled on escalating geopolitical tensions involving Israel-Hamas/Gaza-Middle East. Although the market is still expecting a balancing act by the U.S.-Israel in Gaza for a short and long-term solution to avoid a wider regional conflict, the risk trade is being affected by various war-related headlines and escalating geopolitical tensions. Iran is so far waging a proxy war against Israel primarily through various militant/terrorist organizations like Hamas, Hezbollah and Houthi. Israel is also ‘fighting’ mainly through the intelligence agency Mossad and also army (ISD). But this time, there is a risk of confrontation/war between Israel and Iran and in that case, even the U.S./NATO and even Russia may be involved.

On Friday, Wall Street Futures were briefly boosted on hopes of some peace/ceasefire agreement between Israel-Hamas/Palestine after a report that Palestinian President Abbas to participate in the Cairo summit for peace Saturday. Further Hamas agreed to release a US hostage (Mother-Daughter) on ‘humanitarian’ ground. Subsequently, Gold slips from around 1997 to 1974. But Wall Street Futures also slipped again as Israel termed it as a Hamas strategy to delay the Gaza invasion by the IDF. The U.S. and EU/Europe are all advising Israel to go slow on the Gaza invasion plan, and Israel may also itself considering it as the last option after exhausting all other options to secure the release of around 200 hostages held by Hamas.

On late Friday, Hamas said: “We are working with mediators to close the civilian file if security conditions are appropriate”. Hamas release of two hostages is a first step, discussions are ongoing for more releases - Source Briefed on Negotiations. Hamas release of two hostages is a first step, discussions are ongoing for more releases - Source Briefed on Negotiations.

Hamas freed two American citizens who had been imprisoned in Gaza. Leaders from across the region are gathering in Cairo on Saturday for the Middle East crisis/peace summit. The Israeli military claimed to have struck Hamas targets in Gaza overnight. In response to fire from Lebanon, Israel struck Hezbollah assets and evacuated residents near the border. The Iran-backed militant group claimed to have launched guided missiles at several Israeli targets.

Israel-U.S. is increasing pressure on Hamas by positioning huge military assets at the Gaza border for any invasion through land. In the meantime Israel is systematically destroying all Hamas war/terrorism infra including underground tunnels, so that Hamas is forced to release around 200 hostages of its own without a major escalation in regional confrontation. Israel is trying to release those hostages from Hamas through surgical strikes, being supported by U.S./NATO indirectly (laser-guided tech to locate underground tunnels) or even directly (through unofficial mercenaries).

If this strategy works, then there will be no major regional war; otherwise, there may be some major regional conflicts involving Iran, Syria, Lebanon/Hezbollah, Egypt, and Yemen. Although the U.S. is trying its best to avoid such a scenario, it’s not guaranteed. If such a major regional war breaks out, then there will be a major risk-off trade and vice versa. But as per some reports, Israel aims to destroy Hamas and make a new ‘friendly’ security regime.

On Friday, Fed’s Bostic again popped up and said:

·         The deficit will become more of an issue as debt service increases

·         We are not going to see a recession

·         Many businesses still have cash, blunting a rise in market yields (does not need borrowed funds)

·         The economy's long-term trend is likely going the Fed's way

·         The Fed will need to be cautious, patient, and resolute

·         The economy still has a lot of momentum, inflation will ebb slowly

·         Late 2024 is possibly a time when the Fed would cut rates

·         I don't know if the neutral rate has changed, it could be a higher

·         I don't think the Fed will cut rates before the middle of next year

·         We are not going to see a recession, inflation will go to 2%

·         Businesses are bracing for a slowdown

·         Business contacts say a slowdown is coming

·         The economy has been resilient

·         Inflation has come down a lot and should continue

On Friday, Fed’s Harker said:

·         I'm hearing the economy is softening faster than thought

·         I'm hearing inflation easing faster than thought

On Friday, Fed’s Mester said:

·         The Fed still has perhaps a couple more years of balance sheet cuts

·         Balance sheet drawdown should happen regardless of interest rate moves

·         My forecast shows rates are within one hike of peak

·         Looking at lots of data on monetary policy, including money supply

·         I can't say for sure whether monetary policy is definitely at the peak

·         The Fed has underestimated inflation levels until only recently

·         Fed is at or near the peak of the rate hike cycle

·         Data shows signs of moderating wage gains, labor markets showing moderation and resilience

·         The Fed must not be complacent about getting inflation back to 2%

·         It is possible recent developments could slow the move down in inflation

·         My outlook aligns with the Fed forecasts, eyeing one more increase

·         Fed rate decisions will be driven by incoming economic data

·         The Fed needs to be nimble with monetary policy right now

·         Inflation is cooling but still too high, risks tilted to the upside

Biden Admin asked Congress for nearly $106 billion in supplemental funding for Ukraine, Israel, and border protection. The US10Y bond yields back away from 5%, the highest since 2007 amid the Fed’s higher for longer policy, elevated interest rate and inflation, higher issuance/supply of debts to fund growing fiscal deficits, and lower demand/Fed’s QT.

On Friday, the U.S. Treasury Secretary said:

·         The US FY23 fiscal/budget deficit was at $1.695T vs FY22 $1.375T deficit

·         The US fiscal 2023 deficit largest since the COVID-fueled gap in 2021, exceeds all pre-COVID deficits

·         US September budget deficit of $171 bln (consensus $78.6 bln deficit) vs Sept 2022 deficit of $430 bln

On Friday, the Fed financial stability report said:

·         Risks posed by economic weakness in China increasingly cited as near-term risk

·         Persistent inflation and monetary tightening, as potential losses in commercial real estate (CRE), are the most cited near-term risks to financial stability

·         Russia-Ukraine war seen as a diminishing risk, ranked no. 11 in the latest report vs no. 1 in the Spring 2022 report, shortly after the war began

·         Corporate bond performance remains solid, but signs of deterioration have emerged since May

·         Some contacts see CRE stress trigger

·         Worsening geopolitical tensions could hurt global markets

Conclusion:

The Fed will be on hold with a hawkish stance in November and December and hold the same at least till Sep’24.

The average sequential rate for U.S. core CPI (seasonally unadjusted) was around +0.11% in 2020, +0.45% in 2021-22, and estimated +0.35% in 2023. At a current average sequential rate of +0.25% in the last few months, the annual core CPI should be around +4.3% in Dec’23 against +5.7% in Dec’22.

Looking ahead, if the rate of average sequential core CPI further declines to around +0.25% in 2024 and +0.15% in 2025, then the annual core CPI would be around +3.0% by Dec’24 and +2.0% by Dec’25-in line with Fed’s present projections. Thus there is a need for a higher restrictive rate for longer policy at least till Sep’24. By Sep’24, U.S. core CPI should be around +3.0% and then the Fed may go for rate cuts of at least -50 bps a quarter. Fed may not hike further in Nov/Dec’23, keeping terminal repo rate at +5.50% with a hawkish hold stance at least till Q1CY24/H1CY24.

Thus Fed is preparing the market for a hawkish hold stance in November and most probably in December too and end the current tightening cycle. Fed may go for a hawkish hold policy action/stance on 1st November amid excuses of Israel-Hamas war/simmering ME geopolitical tensions and rising 10Y US bond yield. But the Fed may continue to project at least another hike in December and one hike in H1CY24 (March/June) to continue its hawkish hold stance and to ensure tighter financial conditions and also Fed credibility. The Fed is now preparing the market for higher for longer policy and another hike in December (if required); then a possible end of the tightening cycle by Dec’23.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation (CPI+PCE) =5.50% (for 2022); H1CY23 average core inflation around +5.40% (~5.50%)

If the Fed pauses in Nov/Dec’23 and keeps the terminal repo rate at +5.50% against the average projected core CPI for 2023 around +4.9% (~5.0%), then BOE may not also hike further, but ECB may have to hike by another +50 bps for a terminal repo rate at +5.25% to keep policy parity with Fed and control imported inflation. ECB is far behind the curve and wasted the first 4-months of 2022 by not hiking in line with the Fed.

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price stability and soft-landing.

Even after the expected pause after Nov’23, the Fed may keep open for further hikes by projecting at least another 25/50 bps hike in H1CY24 (one rate hike at Q1 and Q2) if core inflation does not fall as expected as a result of the still hot labor market and other demand-related factors.

Market wrap:

On Friday, Wall Street Futures slumped on lingering geopolitical tensions involving Israel-Hamas/Gaza City, the Fed’s higher for-longer policy, elevated bond yield/borrowing costs, and mixed earnings report. The market is now concerned that the Israel-Hamas conflict and any big-scale Gaza ground invasion by IDF will escalate into a wider Middle Eastern/regional war. Thus Gold, Silver jumped on haven appeal, while stocks fell on risk aversion. Oil surged on possible logistic turbulence for any wider Middle East regional conflict.

On Friday, blue chip DJ-30 slumped stumbled almost -300 points from the session high and closed around 33255, down by -0.80%; broader SPX-500 tumbled -1.26%, while tech-savvy NQ-100 stumbled -1.50%. led by Tesla. American Express also tumbled on subdued guidance and disappointing card volume despite reporting upbeat earnings.

Techs led by AI Chip stock Nvidia were under pressure on the growing chip/tech/cold war between the U.S. and China. The latter (China) is also curbing its rare earth minerals/materials including graphite exports to the U.S., which is used to make the chipboard (PCB). China is the world’s largest producer and supplier of graphite. The U.S. is also curbing sophisticated state-of-the-art chip-making machines/tools to China, but China may have already acquired the capability/skill to make such tools.

On Friday, Gold and oil stumbled from the session high on the ease of Middle East tensions after Hamas released two US hostages and expressed a desire for further negotiations (after getting hammered by IDF). Oil was also dragged as the US will buy SPR oil at any given time with a $10 discount from the existing market rate and also at lower than expected volume.

On Friday, Wall Street was dragged by all major 11 sectors led by energy (oil slumped), techs, consumer discretionary, financials, materials, communication services, utilities, industrials, real estate, healthcare, and consumer staples. Dow was only supported by Goldman Sachs, Merck, Walgreens Boots, J&J, and Coca-Cola, while dragged by American Express (subdued report card), Salesforce, Boeing, Apple, Microsoft and Chevron.

Technical trading levels: DJ-30, NQ-100 Future, Gold and oil

Whatever the narrative, technically Dow Future (33255) now has to sustain above 33300 levels for any rebound to 33550/33700-33825/33950 and rally further to 34050/34150-34325/34600 and 35000/35150-35350/35850; otherwise sustaining below 33250, may fall to 33000-32950 levels, which should provide good buying support (depending upon Israel-Gaza news flow).

On the flip side, if Israel launches a big ground invasion in Gaza, resulting in wider Middle East conflict, then sustaining below 32950-900, Dow Future may further fall to 32750/32600-32500/400 and further to 32150/31700-31595/31000 and even 29300-28600 in the coming days.

Similarly, NQ-100 Future (14663) now has to sustain over 14600-550 levels for a rebound to 14750/900-15150/15350 and may further rally to 15475/15655-15775/16100 in the coming days; otherwise, sustaining below 14500, may further fall to 15450/14350-14250/14175 and 14000/13890-13650/13125 in the coming days.

 

Gold (XAU/USD: 1980) now has to sustain above 1990 for any further rally to 2005/2020-2035/2055 and 2075/2085 levels; otherwise, sustaining below 1985, may again fall to 1975/1965-1955/1940 and further to 1920/1910-1900/1895 and 1885/80 -1870/60-50/40 and 1825/1810-1798*/1770 level in the coming days.

Similarly, oil (88.15) now has to sustain over 90.00 for a further rally to 91.00/92.50-93.50/95.50 and 100.00/105.00; otherwise sustaining below 88.50, the oil may again fall to 87.00/86.30-85.80/84.00 and 83.00/82.00-81.00/80.00 and 78.75-77.75 in the coming days.