Gold and oil surged, Dow slid on Gaza war escalation

On Wednesday, Wall Street Futures slid on lingering uncertainty about the Israel-Hamas Gaza war trajectory, the Fed’s ‘higher for longer’ policy, and mixed/subdued corporate report card/updates. As per some reports Israeli PM Netanyahu has won private backing from U.S. President Biden to press ahead with a ground invasion of Gaza. Biden reportedly told Netanyahu he remained ‘fully in support’ of Israel’s plans in a closed-door meeting. Biden will address the nation on the response to Hamas' terrorist attacks against Israel and Russia's war against Ukraine at 8 pm US Eastern time on Thursday, 19th October, which is 0000 GMT.

In the early Thursday Asian session, Wall Street Futures further slipped led by Nasdaq on a subdued report card from Tesla. Also, simmering geopolitical tensions over Israel-Gaza/Hamas kept risk trade under stress. The UN Secretary-General Guterres is scheduled to visit Egypt on Thursday after U.S. President Biden visits Israel, and UK PM Sunak has begun a two-day visit to the Middle East/Israel region.

Oil slid despite Middle East tensions when the US lifted some sanctions on Venezuelan exports; gold was stable due to safe-haven buying. But oil was also boosted Wednesday as Iran called for an all-out oil embargo following a rocket/missile explosion at a hospital in Gaza allegedly by Israel that hindered diplomatic efforts to defuse the Middle East crisis. But now Israel is insisting that it was a Hamas rocket misfired on the Gaza hospital; the U.S. is also supporting this narrative.

On Thursday, Wall Street Futures stumbled from Powell boost high amid escalation of Gaza geopolitical tensions; gold got a further boost:

·         Official: Israeli military has 'green light' to move into Gaza

·         Drone Attacks Syrian Gas Field

·         Drones attacked a US Military Base in Southern Syria by suspected Iran-backed operation

·         Drones and rockets attack Iraq's Ain Al-Asad U.S. airbase

·         Iraqi resistance forces claim responsibility for the attack on US al-Asad military base

·         Drones and rockets attack target Iraq’s Ain Al-Asad airbase, multiple blasts heard inside the base

·         US/Pentagon Official: US Navy warship traveling near Yemen intercepted multiple projectiles

·         Pentagon: We cannot say for certain where missiles were targeting, but potentially towards targets in Israel

·         Pentagon: Confirms that a US warship shot down three missiles and drones in the Northern Red Sea

·         EC Pres. von der Leyen: 93% of Hamas' equipment comes from Iran. It is important to step up sanctions on Iran and crack down on evasion

·         Israel plans buffer zone in Gaza after Hamas war and Palestinians in territory ‘will never be able to come close to the Israeli border’

·         Jordan's Foreign Minister Safadi: We fear the worst in the ongoing Gaza war, based on all the indications

Apart from ongoing simmering Middle East geopolitical tensions, on Thursday, all focus of the market was also on Fed Chair Powell’s speech and Q&A comments at the prestigious Economic Club of NY, which is now an annual event involving Fed Chair.

Powell said in his prepared opening remarks:

Before our discussion, I will take a few minutes to discuss recent economic data and the outlook for monetary policy.

Recent Economic Data

Incoming data over recent months show ongoing progress toward both of our dual mandate goals—maximum employment and stable prices.

Inflation

By the time the Federal Open Market Committee (FOMC) raised rates in March 2022, it was clear that restoring price stability would require both the unwinding of pandemic-related distortions to supply and demand, and also restrictive monetary policy to cool strong demand and give supply time to catch up. These forces are now working together to bring inflation down.

After peaking at 7.1 percent in June 2022, 12-month headline PCE (personal consumption expenditure) inflation is estimated at 3.5 percent through September. Core PCE inflation, which omits the volatile food and energy components, provides a better indicator of where inflation is heading. Twelve-month core PCE inflation peaked at 5.6 percent in February 2022 and is estimated at 3.7 percent through September.

Inflation readings turned lower over the summer, a very favorable development. The September inflation data continued the downward trend but were somewhat less encouraging. Shorter-term measures of core inflation over the most recent three and six months are now running below 3 percent. However, these shorter-term measures are often volatile. In any case, inflation is still too high, and a few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal. We cannot yet know how long these lower readings will persist, or where inflation will settle over coming quarters. While the path is likely to be bumpy and take some time, my colleagues and I are united in our commitment to bringing inflation down sustainably to 2 percent.

The labor market

In the labor market, strong job creation has met a welcome increase in the supply of workers, due to both higher participation and a rebound of immigration to pre-pandemic levels. Many indicators suggest that, while conditions remain tight, the labor market is gradually cooling. Job openings have moved well down from their highs and are now only modestly above pre-pandemic levels. Quits are back to pre-pandemic levels, and the same is true of the wage premium earned by those who change jobs. Surveys of workers and employers show a return to pre-pandemic levels of tightness. Indicators of wage growth show a gradual decline toward levels that would be consistent with 2 percent inflation over time.

Growth

To date, declining inflation has not come at the cost of meaningfully higher unemployment—a highly welcome development, but a historically unusual one. Healing of supply chains in conjunction with the rebalancing of demand and supply in the labor market has allowed disinflation without substantially weaker economic activity. Indeed, economic growth has consistently surprised to the upside this year, as most recently seen in the strong retail sales data released earlier this week. Forecasters generally expect gross domestic product to come in very strong for the third quarter before cooling off in the fourth quarter and next year. Still, the record suggests that a sustainable return to our 2 percent inflation goal is likely to require a period of below-trend growth and some further softening in labor market conditions.

Geopolitical tensions are highly elevated and pose important risks to global economic activity. Our institutional role at the Federal Reserve is to monitor these developments for their economic implications, which remain highly uncertain. Speaking for myself, I found the attack on Israel horrifying, as is the prospect of more loss of innocent lives.

Monetary Policy

Turning to monetary policy, the FOMC has tightened policy substantially over the past 18 months, increasing the federal funds rate by 525 basis points at a historically fast pace and decreasing our securities holdings by roughly $1 trillion. The stance of policy is restrictive, meaning that tight policy is putting downward pressure on economic activity and inflation. Given the fast pace of the tightening, there may still be meaningful tightening in the pipeline.

My colleagues and I are committed to achieving a stance of policy that is sufficiently restrictive to bring inflation sustainably down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective. We are attentive to recent data showing the resilience of economic growth and demand for labor. Additional evidence of persistently above-trend growth or that tightness in the labor market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy.

Along with many other factors, actual and expected changes in the stance of monetary policy affect broader financial conditions, which in turn affect economic activity, employment, and inflation. Financial conditions have tightened significantly in recent months, and longer-term bond yields have been an important driving factor in this tightening. We remain attentive to these developments because persistent changes in financial conditions can have implications for the path of monetary policy.

Conclusion

My colleagues and I remain resolute in our commitment to returning inflation to 2 percent over time. A range of uncertainties, both old and new, complicate our task of balancing the risk of tightening monetary policy too much against the risk of tightening too little. Doing too little could allow above-target inflation to become entrenched and ultimately require monetary policy to wring more persistent inflation from the economy at a high cost to employment. Doing too much could also do unnecessary harm to the economy.

Given the uncertainties and risks, and how far we have come, the Committee is proceeding carefully. We will make decisions about the extent of additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks.

Thank you. I look forward to our conversation.

Highlights of Powell’s comments:

·         There may still be meaningful tightening in the pipeline

·         We are committed to achieving a sufficiently restrictive policy stance

·         More evidence of above-trend growth, or that the labor market no longer easing, could warrant further monetary policy tightening

·         Significant tightening in financial conditions with higher bond yields can have implications for policy; we remain attentive

·         The present policy stance is restrictive.

·         The extent of additional policy firming and how long to keep policy restrictive will depend on data, outlook, balance of risks

·         The Fed's role is to monitor highly elevated geopolitical tensions that pose important risks to global economic activity

·         Fed’s policy-setting committee (FOMC) is proceeding carefully

·         Lower summer inflation readings are very favorable, September data somewhat less encouraging

·         Inflation is still too high

·         The task of balancing too much tightening vs too little is complicated by a range of uncertainties

·         A few months of good data are only the beginning of what it will take to build confidence in the inflation path

·         I am attentive to data showing the resilience of economic growth and demand for labor

·         Recent data shows ongoing progress toward inflation and employment goals

·         Restrictive monetary policy and unwinding of pandemic distortions working together to bring inflation down

·         The return to 2% inflation is likely to require a period of below-trend growth, some further softening of labor market conditions

·         More evidence of above-trend growth, or that the labor market no longer easing, could warrant further monetary policy tightening

·         Significant tightening in financial conditions with higher bond yields can have implications for policy; we remain attentive

·         We certainly have a very resilient economy on our hands

·         Growth is running above it's long-run trend, which is a surprise

·         The economy is a story of stronger demand

·         There may be ways the economy is less affected by interest rates

·         Interest-sensitive spending is showing the impact of Fed policy

·         We do see policy working through the usual channels

·         It may be that rates haven't been high enough long enough

·         I don't think there's a fundamental shift in how rates affect the economy

·         The fact that we have a strong economy and job market, these are elements we want to see

·         There is no precision in understanding monetary policy lags

·         Markets have been front-running Fed policy changes

·         Household savings are higher and spending has been higher

·         We should be seeing the effects of monetary policy arriving

·         The Fed has slowed on rates to give policy time to work

·         We have to use eyes and risk management to monitor monetary policy impact

·         We are moving carefully with policy decisions

·         Long-run potential growth doesn't change much, is around 2%

·         The economy is very resilient and growing strongly

·         It's very hard to know how the economy can grow with higher rates

·         I don't know where monetary policy will settle

·         The effective lower bound is not an issue for the economy or monetary policy

·         By any reckoning neutral rates ebbed over recent decades and I'm unsure where it is now

·         Models are useful but have to look at what the economy is telling us

·         It does not feel like policy is too tight

·         We may be going into a more inflationary period, but it's hard to know

·         The Fed's issue is trying to get policy right to bring inflation back to 2%

·         With hindsight, it is possible the Fed could have done less during the pandemic

·         Our economy is doing very well

·         Right now the risk is still high inflation

·         Bond yields analysis needs humility

·         Bond yields not showing higher expected inflation or monetary policy view

·         Markets are seeing economic resilience and revising their views

·         Markets may be responding to deficits and Fed balance sheet actions (QT)

·         The bond yield rise is tightening financial conditions

·         The focus on deficits, QT could be part of yield rise

·         Bond yield rise doesn't seem to be about expectations of the Fed doing more on rates

·         We know the fiscal path is ultimately unsustainable

·         The current fiscal situation does not affect the Fed's near-term policy choices

·         Overseas treasury buying has remained robust

·         Business contacts are saying the economy remains strong

·         The cost of capital could be an issue for small companies

·         Fed policy is blunt, but it's what the Fed has to tackle inflation

·         The higher bond yields are producing tighter financial conditions which the Fed wants

·         Higher bond yields are a tightening, and at margin could reduce the need for the Fed to tighten

·         There are many signs the labor market is getting back into balance

·         Wage increases are moderating, and job openings weakening

·         The labor market is gradually cooling

·         I don't think most of the inflation is from the job market, it was demand-driven

·         Bank stress has settled down, but the Fed is still watching for trouble

·         Commercial risk is not a big risk for the biggest banks but, a bigger risk for smaller banks

·         Working with regulators on commercial real estate trouble, there will be losses

·         I don't see systemic risk from commercial real estate (CRE) problems

On Thursday, Fed’s Goolsbee said:

·         Haven't seen a recession and I'm hopeful we can avoid one

·         Housing-shelter component of inflation is a key measure

·         The US labor market has eased but is still strong

On late Thursday, Fed’s Logan said:

·         I am not yet convinced we are moving to 2% inflation

·         Has seen welcome progress on inflation but it's still too high

·         The economy continues to outperform, labor markets still tight

·         Important to have restrictive financial conditions broadly speaking

·         Fed has some time to watch the economy, and markets before deciding on monetary policy

·         Fed has been unified in restoring price stability

·         Some part of bond yield rise is tied to term premiums

·         Some part of bond yield rise is also tied to the strength of economic data

·         The rise in bond yields has been pretty orderly

·         Bond markets are functioning, but still watching for trouble

·         Tighter financial conditions desired will slow the economy

·         Not thinking about when the Fed might cut rates

·         Central bank market support interventions should be rare, transparent

·         Fed has taken important steps to provide market liquidity backstops

·         Anecdotal information is important for policy-making

·         Persistent rise in bond yields could mitigate the need for Fed rate hikes

·         Tighter financial conditions desired will slow the economy

·         NY Fed has an extensive dashboard to monitor money markets

·         The reverse repo facility running down very smoothly

·         Quite uncertain what the right level of reserves is for banks

·         Need to get fed reverse repo facility close to zero

·         Unsure how fast reverse repo facility will shrink

·         sees quite a bit of time left for balance sheet runoff

On late Thursday, Fed’s Harker said:

·         Data is a little stronger than his forecasts and supports more hikes if need

·         A resolute and patient policy stance should enable a soft landing

·         Will support further rate hikes if needed

On late Thursday, Fed’s Bostic said:

·         I haven’t seen a wage-price spiral

·         Wages are a lagging indicator in the current economy

·         Believes that the Fed can control inflation without causing big damage to the jobs market

·         Sees no reason to change the Fed's 2% inflation target right now

·         Fed's main mission remains cooling down inflation

Market wrap:

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.

On Thursday, blue chip DJ-30 stumbled around -250 points, broader SPX-500 tumbled -1%, while tech-heavy NQ-100 slips -0.8%-helped by Netflix )upbeat report card), AT&T, while dragged by Tesla (subdued guidance amid higher borrowing costs). Wall Street was dragged by real estate, consumer discretionary, financials, materials, healthcare, utilities, techs, and energy, while boosted by communication services.

Bottom line:

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

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 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 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.

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

Whatever may be the narrative, technically Dow Future (33825) now has to sustain above 34350 levels for a further rally to 34500-34600 and further to 34825-35070/200-415/850 levels; otherwise, sustaining below 34300, Dow Future may again fall to 34150/34000-33900/33700 and further to 33600/33450-33200-32950 and 31700-31500 levels in the coming days.

Similarly, NQ-100 Future (15036) now has to sustain over 15500 levels for a further rally to 15750/900-16000/655 in the coming days; otherwise, sustaining below 15450/400-15300/200, may again fall to 15000-14700, and further to 14500-14300/175-100/13890 and 13650-13125 levels

Gold (XAU/USD: 1950) now has to sustain above 1935-1940 for any further rally to 1965/1975-1990/2020 and 2080 levels; otherwise, sustaining below 1930-1925, may again fall to 1918/1910-1900/1895 and 1885/80 -1870/60-50/40 and 1825/1810-1798*/1770 level in the coming days.

Similarly, oil (87.25) now has to sustain over 86.50 for 88.30-89.00 for a further rally to 92.00/95.00-100.00/105.00; otherwise sustaining below 88.50-87.50, the oil may again fall to 84.00/82.00-80.50/77.75 in the coming days.