Oil and gold jumped on simmering Israel war tensions; Dow slid

On Thursday, Wall Street Futures were dragged by hotter-than-expected headline inflation (CPI) and core service inflation. The market is now concerned about a ‘higher for longer’ policy stance, which may adversely affect discretionary private as well as government spending and eventually corporate earnings.

Also, simmering Middle East geopolitical tensions involving the Israel-Hamas war are getting wider. Israel has launched a major ground offensive (military action) to reoccupy/retake/control the Gaza Strip and completely ‘destroy’ Hamas. Israeli Military called for the evacuation of all civilians of Gaza City from their homes southwards and announced: “We will operate significantly in Gaza City in the coming days”. Israel PM Netanyahu also warned: “Israel's counter-offensive in Gaza is only the beginning”.

On the other side, Hamas also launched missiles toward Tel Aviv, while another militant organization Hezbollah also vowed to attack Israel from its Lebanon base, which may also provoke/force Iran, Syria, and Lebanon to join/support actively Hezbollah-Hama grand coalition force against Israel. In that scenario, even Russia may be involved indirectly, and the overall situation may also trigger a mini WW-III-like situation (with conventional weapons, not nukes hopefully)! But the Israel Army is also insisting that it’s the ‘Pearl Harbor’ moment for the country and time to wake up from a deep slumber.

On Friday, Israel took a major ground and air offensive over the Gaza Strip after ordering over 1M people for an immediate evacuation. As a result, Gold and silver jumped as haven assets along with USD/US bonds and oil, while the U.S. and European stock markets plunged on risk aversion. Gold jumped from a US CPI panic low around 1870 to almost 1930, while oil also surged from around 82.14 (post-EIA inventory panic low) to almost 87.81. Oil also jumped as The U.S. enforced sanctions on Russian exports.

The market is now concerned that an intensification of Israel's conflict with Hamas that involves Iran may drive oil to even $150 and reduce global GDP by nearly $1 trillion. The likelihood of longer-term increases in US interest rates also decreased risk-taking. The likelihood of another +25 bps Fed rate hike also increased from closer to 30% Wednesday to around 40%; Dow Future stumbled from around 34123 to 33707 on risk aversion and the concern of higher borrowing costs for longer.

On Friday, Wall Street Futures were also buoyed by hopes of reduced Cold War tensions as the U.S. Treasury Secretary Yellen and China's PBOC Chief Pan also discussed how to make the US-China financial working group "substantive and productive. Yellen had a "substantive and productive" meeting with China's Pan.

The US Treasury Secretary Yellen said:

·         PBOC meeting helps to keep US-China relations on track

·         I am not seeing major economic ripple effects from the conflict

On Friday, Fed’s Harker said:

·         It will take time for Fed rate hikes to be fully felt

·         The labor market is coming into a better balance

·         I do not expect to see mass layoffs

·         Auto strikes and renewed student loans will weigh on the economy

·         I expect the unemployment rate to rise to about 4%

·         The labor market turmoil could weigh on the economy

·         Growth to moderate next year but I do not see a recession

·         I see steady disinflation, with it falling to below 3% this year

·         The Fed is likely to be done with rate hikes

·         Tighter credit conditions akin to rate hikes in impact

·         I can’t say for how long rates will need to remain high

·         Absent a stark turn in data, the Fed can hold rates

·         Data will signal the need to adjust policy "either way"

·         Some parts of the economy will feel the impact of AI technology

·         The jury's out on whether AI means a big productivity boost

·         Banks tell Fed there is almost no activity for first-time home buyers

·         Wage pressures are elevated but are moderating

·         The spillover impact of Fed rate hikes on the economy favors holding steady

·         I am seeing some increase in consumer credit trouble, but it's not a major concern yet

·         I prefer core inflation measures to headline

·         An economic soft landing is quite possible

·         There is always a chance of recession but don't expect a downturn

·         The size of budget deficits needs to be addressed

·         Rising interest costs are pressuring the Federal budget

·         Vacancies in CRE are a concern

·         I do not expect to see mass layoffs

·         I support a higher for longer interest rate stance

·         I expect rates will need to stay high for a while

On Friday, former St. Louis Fed President and a known uber-hawk Bullard said:

·         Investors were too complacent about inflation and the Fed might have to increase interest rates as high as 6.00-6.5% if it starts to rise again

·         Fed may need to hike rates further if inflation quickens pace

·         The risk that’s underpriced in markets is that disinflation stalls out or stops altogether and core PCE inflation starts to go up again----That would start a whole new round of consternation among policymakers about whether they’ve done enough-- If that happens the committee will have to contemplate going to 6% or 6.5%

·         One thing that I like about where the FOMC is today is that you’ve got this extra additional rate on the table. I think that prevents the market from saying that the next move has to be down

On Friday, Wall Street was also briefly boosted by an upbeat report card:

Citi Q3CY2023 Earnings were better than expected:

·         EPS $1.63 vs Est. $1.22

·         Rev $20.14B vs Est. $19.26B

·         FICC sales & trading rev $3.56B vs est. $3.25B

·         Investment banking rev. $844M vs Est. $662.8M

·         Equities sales & trading rev $918M vs Est. $964M

·         Total loans $666B vs Est. $661.31B

·         Total deposits $1.27T

·         Operating expense $13.51B vs Est. $13.69B

·         Total cost of credit $1.84B

JPMorgan (JPM) Q3CY2023 Earnings were also upbeat/better than expected:

·         Adj. rev. $40.69B vs Est. $39.92B

·         EPS $4.33 vs. $3.12 (y/y)

·         Loans $1.31T vs Est. $1.32T

·         Investment banking rev. $1.61B vs Est. $1.48B

·         Equities sales & trading Rev $2.07B vs Est. $2.27B

·         Standardized CET1 ratio 14.3% vs Est. 14%

·         JPM sees FY net interest income of about $88.5B vs Est. $87B

Wells Fargo Q3CY2023 Earnings were also above market consensus:

·         EPS $1.48 vs Est $1.22B

·         Rev. $20.86B vs Est. $20.16B

·         Total average loans $943.2B vs Est. $946.47B

·         Provision for credit losses $1.20B vs Est. $1.33B

·         Total avg. deposits $1.34T vs Est. $1.34T

BlackRock Q3CY2023 Earnings were also upbeat:

·         Adjusted EPS $10.91 vs Est. $8.20

·         Rev. $4.52B vs Est. $4.51B

·         Net inflows $2.57B vs Est. $61.74B

·         AUM $9.10T vs Est. $9.23T

·         Net outflows $34.47B vs Est. inflows $11.64B

·         Fixed income net inflows $13.21B vs Est. $27.33B

·         Base fees & securities lending rev. $3.68B vs Est. $3.68B

United Health Q3CY2023 Earnings:

·         Adj. EPS $6.56 vs Est. $6.32

·         Rev. $92.48B vs Est. $91.15B

·         Operating cost ratio 15% vs Est. 14.8%

·         Opium revenue $56.74B at +22% (y/y)

·         Sees FY24 EPS at $23.60 to $23.75 vs previous projections of $23.45 to $23.75

On Friday, the UM (University of Michigan) flash data showed US1Y inflation expectations jumped to +3.8% in October from +3.2% sequentially, above the market expectations of +3.2% and the highest since May’23 amid higher oil prices and hotter-than-expected headline inflation (CPI) at 3.7% for last two consecutive months. On Friday, the UM flash data also showed US5Y inflation expectations surged to +3.0% in October from +2.8% sequentially (at 1 year low) and also above the market consensus of +2.8%.

On Friday, the UM flash data also showed that US consumer sentiment fell to 63.0 in October from 68.1 sequentially, the lowest in five months, and below market estimates of 67.2. The gauge for current economic conditions fell to a five-month low of 63.0 from 68.1 in the previous month and consumers’ future expectations retreated to 60.7 from 66, also the lowest in five months.

The UM noted: "Assessments of personal finances declined about 15%, primarily on a substantial increase in concerns over inflation, and one-year expected business conditions plunged about 19%. However, long-run expected business conditions are little changed, suggesting that consumers believe the current worsening in economic conditions will not persist”.

Market wrap:

On Friday, Wall Street Futures were initially boosted by better-than-expected report cards from banking majors Citi, JPM, Wells Fargo, and BlackRock, but stumbled on risk aversion and the concern of higher borrowing costs for longer. Although Fed’s Harker almost confirmed a Fed pause not only in November but also in December. Wall Street Futures and gold were also undercut by hotter-than-expected US inflation expectations and softer-than-expected consumer sentiment (negative for discretionary consumer spending, when consumers are not at least 90% confident of sufficient/additional future real earnings).

On Friday, Dow Future stumbled from around 34123 to 33707 and closed around 33780 on risk aversion (Israel-Hamas geopolitical tensions) and the concern of higher borrowing costs for longer. Gold and oil surged on simmering Middle East geopolitical tensions as Israel launched/prepared a major military operation to re-control/re-occupy the Gaza Strip.

On Friday, Wall Street was dragged by techs (higher USD, negative for export earnings), consumer discretionary, communication services, industrials, materials, and real estate, while boosted by energy (higher oil), utilities, consumer staples, healthcare, and financials to some extent (upbeat report card by banking majors). Dow Jones was dragged by Boeing (report of some manufacturing defect), and Walgreens Boots (guidance warning). Intel, IBM, Microsoft, Apple, and Caterpillar, while boosted by United Health, Travelers, Chevron, JPM, P&G, and McDonald’s. Blackrock edged down on a mixed report card. For the week, blue chip DJ-30 gained +0.8%, tech-heavy NQ-100 edged up +0.3%, while broader SPX-500 inched up +0.6%.

Conclusion:

Fed may go for a hawkish hold policy action/stance on 1st November amid excuses of Israel-Hamas war/simmering ME geological 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.

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:

Fed may continue the hawkish hold stance not only in Nov/Dec’23 but till at least Q1/H1CY24. Now all focus is on the trajectory of the Israel-Hamas (Middle East) war. If Israel neutralizes Hamas and its war infra in Gaza through its ground offensive in the coming days and announces a ceasefire amid increasing global pressure/concern of a huge humanitarian crisis, then it may help the risk trade. On the other side, if Israel’s latest ground offensive to reoccupy Gaza invites Hezbollah, Syria, Iran, and Lebanon to join Hamas and fight a united front against Israel, then we may have more risk aversion trade.

But the overall slump in Wall Street Futures may be limited because of Israel/Middle East geopolitical tensions if there are no wider conflicts/wars between Israel and almost 10 countries/militant organizations (Hamas, Hezbollah, Lebanon, Syria, Jordon, Iran, Iraq, Yemen, and Sudan). In that scenario, even the U.S. and Russia/China may be involved directly/indirectly. Above all, the U.S./Europe and China/India may not allow such wider conflict, which may take the shape of a mini-WW-III.

On the other side, the Fed may not hike further due to simmering Middle East geopolitical tensions, which may affect financial stability and also the fact that core inflation is gradually softening and the US10Y bond yield surging, resulting in higher borrowing costs for the U.S. government. Gold is getting a dual boost of Israel-related risk aversion and Fed pause/pivot stance.

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

Whatever may be the narrative, technically Dow Future (33780) now has to sustain above 34200 levels for a further rally 34350/34450-34555/34650 and further to 34825-35070/200-415/850 levels; otherwise, sustaining below 34150/34000-33900/33700 may again fall to 33600/33450-33200-32950 and further to 31700-31500 levels in the coming days.

Similarly, NQ-100 Future (15122) 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: 1928) now has to sustain above 1935-1940 for any further rally to 1955/1975-1990/2020 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 (87.64) now has to sustain over 89.00 for a further rally to 92.00/95.00-100.00/105.00; otherwise sustaining below 88.50, the oil may again fall to 85.00/82.00-80.50/77.75 in the coming days.