Dow slid on talks of an imminent Iran attack on Israel

On Wednesday, Wall Street Futures, Gold, and UST briefly slid on hotter-than-expected ADP private payroll job addition including wage growth. But Wall Street Futures, Gold, and UST eventually recovered and surged on softer than expected ISM Service PMI report; also overall S&P Global Service PMI data indicates slowing private service activities, although Manufacturing may be out of recession. Thus S&P Global Composite PMI remained steady at 62.1 in March against 52.5 scaled in February (8-months low). Also, there was a sharp drop in input cost prices for the service providers in the PMI survey boosted the risk-on sentiment further on hopes & hopes of an early Fed pivot/cut (from June 24).

But Wall Street Futures also stumbled again from the session high in late-day trading after Fed’s Powell, Bostic, and Kugler sounded more hawkish than expected as all of them indicated rate cuts in H2CY24 provided core inflation dips as being expected; Bostic even reiterated his assumption of only -25 bps rate cut (once) in H2CY24. But Gold ($2300) and oil ($86.50) surged amid the war of words between Israel and Iran after the destruction of the Iranian Consulate in Damascus (Syria) by Israel, which is blaming Iran as the main state sponsor of various terrorist groups (Hamas, Hezbollah, Houthi, etc) involved in attacking Israel.

On Thursday, Wall Street Futures got some boost amid renewed tech/AI optimism and higher-than-expected initial jobless claims, which may prompt the Fed for an early rate cut (?). But Wall Street Futures soon stumbled on hawkish Fed talks led by Kashkari indicating fewer rate cuts or even no rate cuts in 2024. And Wall Street Futures tumbled after a report Iran may launch an imminent (within Friday) drone/missile attack on Israel in retaliation to Israel’s missile attack on its consulate/embassy at Damascus (Syria).  The Israeli precision air strike at Iran’s consulate caused the deaths of three commanders and four officers of the Iranian Armed Forces (IRGC/Quds) Monday, who were allegedly in charge of Iran's covert intelligence and military operations across Syria and Lebanon.

On Tuesday, Iran's supreme leader Khamenei vowed revenge against Israel: "The evil regime will be punished by the hands of our brave warriors--- and will make them regret this crime and the like by God's grace."

Iran’s foreign minister said: “We consider this aggression to have violated all diplomatic norms and international treaties. Benjamin Netanyahu has completely lost his mental balance due to the successive failures in Gaza and his failure to achieve his Zionist goals.”

Iran’s ambassador to Syria said Iran’s response to the strike would be at the same magnitude and harshness”.

Also, the latest data suggests GPRS/GNSS jamming across Israel as a precautionary defensive action to counter such an attack by Iran. The jamming of GPRS/GNSS service by IDF (Israeli Defense Force) is an attempt to prevent guided missiles and drones from hitting critical military/civilian targets deep within the country. The IDF is now at a high alert position along with all embassies across the world; reserve soldiers have been also called to strengthen air defense within the country.

Iran may also use proxies such as Houthis to attack Israel and US ships/bases at the Red Sea and other Middle East areas. Iran may choose this Friday – the last in the holy Muslim month of Ramadan and Iran’s Quds (Jerusalem) Day – to respond to the Damascus strike, either directly or through a proxy. Iran has to launch an attack on Israel directly/indirectly for domestic political compulsion in retaliation for the Damascus attack.

The Israeli PM Netanyahu said his country would harm ‘whoever harms us or plans to harm us’, while U.S. President Biden assured Netanyahu of active support to Israel in the face of Iran threats, despite Biden/G7/NATO not happy about the defiance of Netanyahu in launching the war in Rafah and continuing loses of civilians in the overall Gaza war including recent horrific deaths of Kitchen aid-workers (WCK) of an international agency. Ahead of the Nov’24 election (Muslim votes), Biden is now pressuring Netanyahu for an immediate ceasefire and restoration of civilian aid.

On Thursday, the White House released the U.S. version/readout of telephonic calls between Biden and Netanyahu, which lasted almost 30 minutes and reportedly was quite ‘hot’:

“President Biden spoke by telephone with Prime Minister Netanyahu. The two leaders discussed the situation in Gaza. President Biden emphasized that the strikes on humanitarian workers and the overall humanitarian situation are unacceptable. He made clear the need for Israel to announce and implement a series of specific, concrete, and measurable steps to address civilian harm, humanitarian suffering, and the safety of aid workers. He made clear that U.S. policy with respect to Gaza will be determined by our assessment of Israel’s immediate action on these steps. He underscored that an immediate ceasefire is essential to stabilize and improve the humanitarian situation and protect innocent civilians, and he urged the Prime Minister to empower his negotiators to conclude a deal without delay to bring the hostages home. The two leaders also discussed public Iranian threats against Israel and the Israeli people. President Biden made clear that the United States strongly supports Israel in the face of those threats.”

Overall, Israel's diplomatic ties with key Gulf countries like the UAE are near breaking point. The UAE has announced a suspension of diplomatic coordination with Israel in the wake of the death of seven World Central Kitchen (WCK) humanitarian workers in Gaza.

Meanwhile, Trump, who may return to the White House after the Nov’24 election, said: “Israel is ‘losing the PR war: Israel is receiving bad press and creating negative public sentiment because of its social media strategy, which includes posting images of destruction in the Gaza Strip. They’re releasing the most heinous, most horrible tapes of buildings falling. And people are imagining there are a lot of people in those buildings, or people in those buildings, and they don’t like it----I don’t know why they released wartime shots like that. I guess it makes them look tough. But to me, it doesn’t make them look tough---They’re losing the PR war. They’re losing it big. But they’ve got to finish what they started, and they’ve got to finish it fast, and we have to get on with life.”

Late Thursday, there was a report that Quds Brigades (Iranian proxies) claimed a rocket attack on southern Israel. The armed wing of the Palestinian Islamic Jihad said it has fired rockets from the Gaza Strip toward Southern Israeli cities, while IDF also confirmed the interception of two rockets and also ‘minor damage’.

On Thursday, Fed’s Harker said:

·         Inflation is still too high

On Thursday, Fed’s Barkin said:

·         I am optimistic keeping rates 'somewhat restrictive’ can return inflation to target

·         Early 2024 data is less encouraging, raises the issue of whether the outlook is shifting

·         It is smart for the US central bank to take its time on interest rate cuts

·         Tight Fed policy will eventually slow the economy further, but that doesn’t mean painful job losses in a less vulnerable economy

·         Optimists could still see a soft landing ahead given economic strength; pessimists could note signs of weakening demand or evidence of persistent inflation

·         Fed officials are all looking at the same data, but it is easy to draw different conclusions

·         Keeping rates somewhat restrictive, inflation can hit 2%, expect high rates will eventually slow the economy further

·         No case to be made that 2% inflation is not achievable; adhering to that target has brought benefits

·         It is conceivable that the 2% target is met without shelter inflation returning to what was considered normal levels

·         More than conceivable that the Fed return to the 2% target without a substantial rise in unemployment

On Thursday, Fed’s Goolsbee said:

·         Housing inflation is my most valuable indicator for the immediate future

·         If housing inflation does not come down, would be very difficult to return inflation to 2%

·         I had been expecting it to come down more quickly than it has

·         The biggest danger to the inflation picture is the continued high inflation in housing services

·         Inflation in core services ex housing has come down more than expected

·         The last two months of inflation data are a bump; can't write it off as pure noise

·         Risks to inflation and employment mandates have moved into a better balance

·         I will be watching inflation developments closely

·         If we stay restrictive for too long, we will likely see employment begin to deteriorate

·         Housing inflation has to come down; I still think it will; if it doesn't, that is a threat to our 2% target

·         We are pretty restrictive on policy so the question is how long we stay there

·         I want to be more convinced we're on the path to 2%

·         Things have moved sideways on inflation

·         In March I jotted down two rate cuts this year, but if inflation continues to move sideways, makes me wonder if we should cut rates at all this year

On Thursday, Fed’s Mester said:

·         The economy and monetary policy are "in a good place"

·         I expect growth will be a bit above the trend this year

·         I don't think the disinflation pace this year will match last year

·         I expect progress toward 2% inflation to continue

·         I do anticipate we'll be in a position to lower the Fed funds rate later this year

·         I need more evidence inflation is moving down

·         We should think about cutting rates as inflation falls

·         I want a couple more months of data to assess inflation.

·         My long-term neutral estimate was raised to 3% from 2.5% in last month's SEPs

·         Expects to be in a position to lower rates later this year

·         Wage-inflation gap has narrowed but persists

·         The Fed is well-positioned to respond to both sides of the mandate

·         If we slow the QT run there's less likelihood of running into a September 2019 situation

·         I'd be comfortable reducing the pace of runoff soon

On Thursday, Fed’s Kashkari said:

·         It's possible the Fed won't cut this year if inflation stalls

·         It's a question of why cut rates if the economy remains strong

·         I don't see any reason why when we cut the federal funds rate we can't continue with our balance sheet plan

·         Need to see more inflation progress before cutting rates

·         Still no legitimate use case for Bitcoin

On Thursday, Fed’s Barkin said:

·         I am optimistic keeping rates 'somewhat restrictive’ can return inflation to target

·         Early 2024 data is less encouraging, raises the issue of whether the outlook is shifting

·         It is smart for the US central bank to take its time on interest rate cuts

·         Tight Fed policy will eventually slow the economy further, but that doesn’t mean painful job losses in a less vulnerable economy

·         Optimists could still see a soft landing ahead given economic strength; pessimists could note signs of weakening demand or evidence of persistent inflation

·         Fed officials are all looking at the same data, but it is easy to draw different conclusions

·         Keeping rates somewhat restrictive, inflation can hit 2%, expect high rates will eventually slow the economy further

·         2024 data is 'less encouraging' raises the issue of whether outlook shifting

·         No case to be made that 2% inflation is not achievable; adhering to that target has brought benefits

Market impact:

On Thursday, Wall Street Futures, Gold slipped from soft jobless claims high on hawkish talks by the Fed, now indicating rate cuts in H2CY24, most probably from Sep’24 against present market expectations from Jun’24 (implied probability reduced from around 66% to 60%). And Dow/Nasdaq/S&P 500 Future tumbled on an escalation of Gaza War/Middle East tension after the report that Iran may be preparing an imminent drone/missile attack on Israel either directly or indirectly; Yen, US bond surged along with gold, oil to some extent; USDJPY, GBPUSD and also EURUSD slid. Dow Future tumbled from around 39750 to almost 38850, but recovered slightly and now hovering around 39000 as Iran may have already launched a missile attack late Thursday through its proxy Houthi.

In any way, Iran may again launch a retaliatory attack on specific Israel targets by Friday/weekend after ‘duly informing’ the US/Israel about the coordinates/location of the specific target, so that it could be emptied before the attack to minimize human casualties; we have seen this narrative when Iran launched a ‘huge missile attack’ on a US military base in Iraq a few years ago in retaliation of the killing of its IRGC chief by the US. Iran may not launch an all-out war against Israel but may launch a targeted ‘well anticipated’ attack on Israel to satisfy domestic political compulsion.

On Thursday, blue chip DJ-30 tumbled almost -539 points, the sharpest single-day fall since Mar’23; tech-heavy NQ-100 and broader SPX-500 slid around 1.4% and 1.2% respectively. Wall Street was dragged by almost all the sectors led by techs, healthcare, communication services, banks & financials, consumer discretionary, materials, industrials, real estate, consumer staples, utilities and energy. Apart from Chevron and Walmart, all other DJ-30 scrips were in moderate and deep red. Scrip-wise, Wall Street was dragged by Salesforce, 3M, American Express, Amgen, McDonald’s, Goldman Sachs, Merck & Co, Caterpillar, Walt Disney, IBM, Intel, AMD, NVIDIA, Micron Nike, Amazon, Cisco, Boeing, Apple, Microsoft and Home Depot.

Conclusions:

The Fed may go for -75 bps rate cuts in September, November, and December’24. By 18th September (Fed MPC date), the Fed will have complete data for core inflation and also unemployment/real GDP data for H1CY24 and also Aug/July’24 to have the required ‘higher confidence’ to go for rate cuts. Fed may bring down the repo rate to +4.75% by Dec’24 from present +5.50%.

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.6%. Fed may cut 75 bps in H2CY24 if the 6M rolling average of core inflation (PCE+CPI) indeed eased further to +3.0% by H1CY24.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C-D)*(E-B)

=1.50+2.00+ (2.60-2.00)*(4.50.00-2.00) =1.00+2+ (0.60*2.50) = 3.00+1.50=4.50% (By Dec’24)

Here:

A=desired real interest rate=1.50; B= inflation target =2.00; C= Actual real GDP growth rate for CY23=2.6; D= Real GDP growth rate target/potential=2.00; E= average core CPI+PCE inflation for CY23=4.50

Fed may announce a plan for QT tapering/closing in the May meeting and should have closed the same before going for rate cuts in H2CY24. Fed, the world’s most important central bank may not continue QT (even at a reduced pace) and go for rate cuts at the same time as QT, and rate cuts are contradictory, although Fed/Powell kept the option open, at least theoretically. Thus assuming an absurd/bizarre phenomenon, the Fed may go for -75 bps rate cuts in H2CY24, most probably from Sep’24 after deciding about the possible B/S size to ensure money market stability

Looking ahead, the Fed may keep B/S size around $6.55T, around pre-COVID levels to ensure financial/Wall Street stability along with Main Street stability (price stability and employment stability). Fed’s B/S size is presently around $7.50T (Mar’24 end). Depending upon the actual rate/reaction in the repo/funding market, the Fed may taper the QT from the present $0.095T/M to 0.050-0.075T/M for 20-12 months from May’24;i.e. Fed may end the QT by May’25-Dec’25 at B/S size around $6.55T. This is lower than the earlier market estimate of $7.00T and thus should be seen as more hawkish. Also, rate cuts along with QT (even with slower pace/tapering) should be less hawkish.

Ahead of the Nov’23 U.S. Presidential election, White House/Biden/Fed/Powell is more concerned about elevated inflation rather than the labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some incumbency wave (dissatisfaction) among general voters against Biden admin (Democrats).

Thus Fed is now giving more priority to price stability than employment (which is still hovering below the 4% red line) and is not ready to cut rates early as it may again cause higher inflation just ahead of the November election. Fed may hike only from Septenber’24, which will ensure no inflation spike just ahead of the Nov’24 election (as any rate action usually takes 6-12 months to transmit in the real economy), while boosting up both Wall Street and also Main Street (investors/traders/voters). Fed hiked rate last on 26th July’23 and may continue to be on hold till at least July’24; i.e. around 12 months for full transmission of its +5.25% cumulative rate hikes effect into the real economy.

Overall, the Fed’s mandate is to ensure price stability (2% core inflation), and maximum employment (below 4% unemployment rate) along with financial/Wall Street stability as well as lower borrowing costs for the government. As the US is now paying almost 15% of its tax revenue as interest on debt, the Fed will now not allow the 10Y US bond yield above 4.50-5.00% at any cost.

Bottom line:

Fed may continue QT (even at a slower pace) and go for a rate cut cycle at the same time despite these two policy actions being contradictory. Thus the Fed may go for rate cuts of -75 bps cumulatively in September, November, and December’24 for +4.75% repo rates from the present +5.50%. Fed may bring down further its B/S size from present around $7.5T to $6.55T through QT tapering by May-Dec’25 to keep minimum/ample liquidity for the US funding/money market and also to prepare itself for the next cycle of QE, whatever may be the recession excuse.

The market is now expecting 5 rate cuts (-125 bps) in 2025 against the Fed’s official 2-3 rate cuts; the Fed may go for 4 rate cuts in 2025 if Trump comes to power/White House or even under Biden. Fed’s mandate is now 2% price stability (core inflation), below 4% unemployment rate, and 3.50% US 10Y bond yield to ensure financial stability.

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

Whatever may be the narrative, technically Dow Future (38900), now has to sustain over 38850 for 39000/39200-39600/39800 and may again scale 40000/40200-40600/40700 levels for any further rally to 42600  levels in the coming days; otherwise, sustaining below 38800-38600 may again fall to 38450/38295*-3795037600 and 37050-35550 levels in the coming days.

Similarly, NQ-100 Future (18100) now has to sustain over 18050-18200 for a rebound to 18350/18500-18600/18700 levels and 19000/19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18000, NQ-100 may gain or fall to around 17600/17500-17200/16850 and 16650/16400-15900/15650 in the coming days.

Also, technically Gold (XAU/USD: 2300 now has to sustain over 2325-2330 for any further rally to 2355/2375-2400/2425; otherwise sustaining below 2320/2315-2305/2300, may again fall to 2290/2270-22245/2240, may again fall to 2220/2210 and 2200/2195-2190/2180 and 2175/2145*, and further to 2120/2110-2100/2080-2060/2039 and 2020/2010-2000-1995/1985-1975 and even 1940 may be on the card.