Gold, Oil surged on Israel-Hamas war; Wall Street recovered

On Friday, Wall Street Futures and gold slid, while USD jumped briefly soon after the ‘blockbuster’ NFP Job report headline, but eventually reversed/recovered as the details/fine print of the overall NFP/BLS Job report in September was mixed/goldilocks in nature (rather than upbeat or terrible). Overall, the Fed may still go for another +25 bps hike on 1st November for a terminal repo rate of +5.75% and hold still at least June’24 (H1CY24). On Friday, Gold slipped to almost 1810 soon after the ‘blockbuster’ NFP job report from around 1825, but eventually recovered to almost 1835, and closed around 1831, while USD/US bond yield also stumbled after initial gain. On Friday, oil slid to a low of around 81.50 on the renewed concern of rebalancing.

But on Saturday/late Friday, Middle East (ME) Geopolitical tension soared after Hamas surprised Israel with a barrage of 500 or more rocket attacks, in which many Israeli civilians and foreigners including American citizens were killed. Subsequently, Israel launched a war-like operation on the militant organization Hamas. Although, generally such ME geopolitical tensions don’t have a great impact on the global market/Wall Street, this time it has some effect as the scale of conflict is much bigger and may involve Iran and Russia directly/indirectly. The most extreme scenario involves Israel striking Iran’s nuclear facilities with U.S. approval.

As a result, oil jumped over $87 early Asian session on Monday. Gold, USD, and US bond futures also jumped on haven assets appeal, while Wall Street (indices/stock) Futures tumbled on risk aversion. Gold jumped to almost 1963, while Dow Future made a panic low around 33296, but eventually recovered as such ME geopolitical tensions will not affect corporate earnings of U.S. MNCs or domestic companies significantly and more over energy and defense/military-related stocks got a boost amid higher oil and elevated geopolitical tensions. Also, markets seemed to think developments in the Middle East would lean against further Fed hikes, and perhaps hasten a policy easing next year. Fed fund futures now implied an 86% chance rates would stay on hold in November, and had around -75 basis points of cuts priced in for 2024.

The U.S. is maintaining that it hasn’t seen evidence of Iran’s involvement, On Sunday, the U.S. Secretary of State Blinken said: “We have not yet seen evidence that Iran directed or was behind this particular attack, but there is certainly a long relationship. We don’t have any information at this time to corroborate this account”.

On the other side, both Iran and Hamas denied any such cooperation. Hamas said the group planned the attacks on its own: “This is a Palestinian and Hamas decision”.

In this way, the Hamas strike was intended to hit Israel while it appeared distracted by internal political divisions over PM Netanyahu’s government. It was also aimed at disrupting accelerating U.S.-brokered talks to normalize relations between Saudi Arabia and Israel that Iran saw as threatening. Building on peace deals with Egypt and Jordan, expanding Israeli ties with Gulf Arab states could create a chain of American allies linking three key choke points of global trade—the Suez Canal, the Strait of Hormuz, and the Bab Al Mandeb connecting the Red Sea to the Arabian Sea, disrupting the flow of ME oil including Saudi Arabia’s.

Egypt, which is trying to mediate in the conflict, has warned Israeli officials that a ground invasion into Gaza would trigger a military response from Hezbollah, opening up a second battlefront. Hamas has called on Palestinians in the West Bank and Palestinian citizens of Israel to take up arms and join the fight. There have been limited clashes in the West Bank, but no reports of clashes between Arabs and Jews inside Israel, as happened in May 2021 when Israel and Gaza last engaged in extended combat. The Iranian official said that if Iran were attacked, it would respond with missile strikes on Israel from Lebanon, Yemen, and Iran, and send Iranian fighters into Israel from Syria to attack cities in the north and east of Israel. UAE comes in support of Israel and condemns the attacks by Terrorist Group Hamas.

Overall, Israel is reeling from the deadliest attack it’s experienced in half a century after the militant organization Hamas carried out a surprise offensive early Saturday morning. More than 700 Israelis have been killed in what Hamas is calling Operation Al Aqsa Flood, and at least 490 Palestinians have been killed in retaliatory Israeli strikes on the Gaza Strip. The total number of deaths has surpassed 1,200, including foreign nationals. Iranian President Raisi congratulated Hamas on its victory.

Hamas also took an unknown number of Israelis, both civilians and soldiers, during its hostilities. Israeli PM Netanyahu has declared that his country is at war. Hamas is a designated terrorist group backed by Iran that has governed the Gaza Strip since 2007. Gaza, a small strip of land that is home to over 2 million Palestinians, is one of the most densely populated territories on Earth and has been kept under an Israeli land, air, and sea blockade since 2007.

On late Friday, Fed’s Mester said:

·         Strong jobs data do not change the underlying view on hiring

·         This one report--- continues to say it's a strong labor market, but it is getting a little bit less tight than we saw before----

·         We also in that report saw that wage growth is tempering a bit

·         What we've seen in the economy so far is that it's been a very resilient economy

·         Economic growth has been strikingly strong and yet we're still making progress on inflation

·         We're data-dependent but not data point dependent

·         And there are more numbers between now and the next Fed meeting,

·         I want to see that data before making my call on what needs to happen with monetary policy

On Monday, Fed’s Logan said:

·         Higher yields may mean there's less need to raise rates

·         In setting policy rates, the Fed must take account of financial conditions, which have tightened substantially in recent months

·         If higher long-term rates are due to higher term premiums, there may be less need for the Fed to raise rates

·         It is too soon to say inflation is reaching 2% in a sustainable way

·         High inflation is a top risk and can't allow it to reignite

·         It is far too soon to think about rate cuts in strategy

·         Higher-term premiums could do some work cooling the economy

·         The jobs market is not as hot as a year ago but very strong overall

·         Output and spending have been surprisingly strong but the outlooks for consumers are mixed

·         Continued restrictive financial conditions are needed for price stability

·         The progress on inflation is encouraging too early to be confident it is headed to the Fed's 2% target in a sustainable and timely way.

·         To the extent a stronger economy is behind the rise in long-term rates, the Fed may need to do more

·         I have not seen anything in tightening of bank lending standards that's non-linear

·         Markets suggest average rates could be higher

·         Looking at financial markets and the performance of the economy, the long-term neutral rate may be higher

·         The bulk of the economy is adjusting more quickly to monetary policy

·         I tend to think monetary policy lags are shorter than others

·         Financial conditions tightening have been rapid but orderly

·         There is quite a bit of room for Fed balance sheet runoff

·         The surprising strength of the economy creates risks for inflation

·         Price stability will require some labor re-balance

·         There's a lot of uncertainty over the tradeoff with the unemployment rate

·         We must stay focused on restoring price stability

·         China's slowdown is an important development to watch

·         My focus is on inflation risk and will remain there for some time

On Monday, Fed’s Jefferson said:

·         Employment growth is a good thing

·         We need to be nimble about what is happening in the economy

·         I cannot say if rate cuts might be needed next year until I see what is happening with GDP and unemployment

·         We need to do our work to bring the inflation rate down before we can assess what the long-run R-Star is

·         Current policy is restrictive

·         Data dependence is key, as we're in an unprecedented time

·         We do have to be aware of what Fed policymakers say because that can affect what happens

·         Starting in 2024, more will be hit by the rise in rates

·         As a policymaker, I'm mindful cumulative effect of past rate increases has not been felt

·         The equilibrium real rate in the economy may have increased

·         Fed officials need to proceed carefully to balance the risk of tightening too much

Market wrap:

On Monday, Wall Street Futures recovered from the Israel-Hamas panic low on hopes of a Fed pause in November and the end of the tightening cycle amid intensifying ME geopolitical tensions. Also, less hawkish talks by Fed’s Logan, Jefferson, and Mester helped. Also gold got an additional boost, while USD stumbled. Oil was hovering around $86, at the same opening levels as the U.S. may not be interested in blaming Iran directly.

On Monday, Wall Street was boosted by energy, industrials, real estate, utilities, communication services, techs, healthcare, consumer discretionary, materials, consumer staples, and financials, while dragged by Airline stocks.

Conclusion:

The Fed is now preparing the market for higher for longer policy and another hike in November- then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a final pause in Dec’23. Fed may not be in a hurry to cut rates before Sep’24.

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%)

As there is no significant easing of core inflation, especially core service inflation, the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle. But, if core CPI inflation indeed eased further to below +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).

Looking ahead, oil prices may stay elevated in the coming months between $75-95 instead of the earlier $65-75 despite US efforts to bring more supply from, Mexico, Brazil, Iran, Iraq, and Venezuela. OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $90 will continue to boost energy/transportation/logistics costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $85 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war.

China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices. But at the same time, China is now also producing higher oil by almost 5 mbpd against its demand of around 15 mbpd. China is also taking various steps to increase domestic production of oil rather than being too dependent on Russia, Iran, Saudi Arabia, and even the U.S.

The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.

Going by the present trend/run rate, the U.S. core CPI may fall to +3.8% by Dec’23 and +3.4% by Feb’24, which may keep the Fed to hold on rates at +5.7% till at least Aug’24 before going for any rate cuts -25 bps or even -50 bps each in Sep’24 and Dec’24 (one rate cut every QTR end from H2CY24). Fed would like to boost Wall Street as well as Main Street before Nov’24 U.S. Presidential election. Fed has to ensure a soft landing; i.e. price stability along with financial/Wall Street stability and Main Street stability.

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.

Overall, it seems that the White House would be quite happy if the Fed could bring back core inflation towards 2% on a durable basis, while keeping the unemployment rate below 4% ahead of Nov’24, the U.S. Presidential election. The Fed is itself eager to cut its losses by cutting rates. The U.S. 2Y bond yield is now hovering around +5.15% and may soon scale 5.25-5.50% in hopes of another +25 bps Fed rate hike for a terminal repo rate of +5.75% by Nov’23. 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.

Bottom line:

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

Whatever may be the narrative, technically Dow Future (33786) now has to sustain above 33900 levels for a further rally to 34000/34150-34250 and 34300/34555-34600/34825-35070/200-415/850 levels; otherwise, sustaining below 33800, may again fall to 33650/33450-33200-32950 and further to 31700-31500 levels in the coming days.

Gold (XAU/USD: 1860) now has to sustain above 1840-1850 for any further recovery to 1867/1875-1885/1900 and 1910/1920-1926/1937 and 1952/1970 levels; otherwise, sustaining below 1835, may again fall to 1825/1810-1798*/1770 level in the coming days.

Technically, whatever may be the narrative, oil (86.40) now has to sustain over the 88.00-89.00 area for a further recovery towards 90.50/91.50 and 94.00/96.00-102.00/115.00-120; otherwise sustaining below 87.50, it may correct again towards 82.50-81.40-81.00/80.00-78.75/77.50 and 75.00-70.00/67.00 area in the coming days.