Wall Street mixed on hopes of extended Gaza war pause

On Thursday, Wall Street Futures were almost flat in a holiday-thinned trading day despite the temporary Gaza war truce as the market is still quite concerned about the fragility of the Gaza war pause of only 4-days and the eventual trajectory of the war and whether it will result in a wider regional conflict involving Iran and other Middle East countries. Israel's political and military leadership seems to have been forced to accept the temporary Gaza war pause under immense global and local pressure (relatives of hostages) and vowed to resume the war from next Tuesday (28th November) after the 4-days pause is over (unless Hamas agrees to release additional 10 hostages for an additional day of extended pause).

It seems IDF/Israel is committed to ‘finishing’ Hamas and any terrorist network in Gaza/Lebanon to keep its citizens safe & secure. Most of the Israeli public is not bothered about the so-called ‘genocide’ '-like the situation in Gaza being caused by IDF, while the latter significantly increased the military operation Wednesday/Thursday ahead of the temporary ceasefire that started Friday. IDF also arrested the director of Al Shifa Hospital for alleged collusion with Hamas in maintaining the underground tunnel networks as Hamas control & command center.

In a way, the exchange of captives has started in line with the Gaza war temporary pause agreement; under the truce, a total of 150 Palestinian prisoners held in Israeli jails and 50 captives held in Gaza are to be released over a four-day period that will see a pause in fighting. The pause in fighting could also be extended, with Israel saying it would add one day for every 10 additional Israeli captives released by Hamas.

On Friday, in his first statement since 13 Israeli captives (including 10 dual citizens) were released by Hamas, Israeli PM Netanyahu pledged his administration is committed to returning all the hostages as one of the aims of the war: “We just completed the return of the first of our hostages: children, their mothers, and additional women. Each of them is an entire world. Returning the captives is one of the aims of the war and we are committed to achieving all the aims of the war (including the complete elimination of Hamas).”

On Friday, an Israeli military spokesman said 13 captive releases by Hamas are only the beginning and warned that the days ahead would be complex but that the Israeli army (IDF) would not stop until all captives have been freed. He called the return of captives “a moral duty” and added that “the safety of our fighters” is Israel’s top priority during the four-day break in fighting in Gaza.

On Friday, U.S. President Biden said today’s captive release was only a start and it’s unclear when the first American captives to be released:

·         Today, we can also be thankful for families being reunited with loved ones who have been held hostage for nearly 50 days

·         The deal was reached through extensive US diplomacy, including numerous calls I made to leaders across the region

·         This deal also is structured to allow a pause to continue to allow more captives to be released. That’s our goal

·         It’s only a start, but so far it’s gone well

·         We don’t know when the first American hostages will be released. We don’t know their conditions. We don’t know the specific hostages who will be released

·         In the next hour or so we’ll know what the second wave of releases are

·         I’ve encouraged the Prime Minister (Netanyahu) to focus on trying to reduce the number of casualties while he is attempting to eliminate Hamas, which is a legitimate objective. That’s a difficult task and I don’t know how long it will take

·         I don’t trust Hamas to do anything right. I only trust Hamas to respond to pressure

On Friday, a Qatari foreign ministry spokesperson said:

·         Doha had maintained direct lines of communication with both sides and the International Red Cross

·         Qatar focused on a mediation role as the truce is liable to fall through at any moment should there be delays in releasing captives or outbreaks of fighting

·         Qatar continued to monitor the situation and relay information between Israel, Hamas, and the Red Cross to ensure that any issues that occurred were immediately addressed

·         We thank all the parties involved

·         Qatar hoped that there would be a buildup of momentum toward extending this pause beyond the initial four-day period

Overall, it now seems that Hamas will begin to release US hostages gradually at a later stage and will also ensure an extended pause beyond 28th November till at least mid-December or even till Christmas (by releasing 10 additional hostages for one/two days of additional pause). In the meantime, Israel/IDF/Mossad may continue targeted surgical operation against specific Hamas target/leadership rather than an all-out Gaza war (as most of Northern Gaza is already destroyed and now have limited Palestine people). Israel is already now under huge pressure from all major global powers including the U.S., Europe, China and Russia for an extended pause/full ceasefire and a permanent Palestine peace solution (separate state/country under an able administration).

Now from geopolitics to economics, on Friday, the S&P Global flash data shows U.S. Manufacturing PMI fell to 49.4 in November from 50.0 sequentially, below market expectations of 49.8. The reading pointed to the biggest decline in operating conditions at private manufacturing firms in three months, resuming the period of contraction seen for much of the past year. Private businesses continued to run down their stocks of purchases and finished items amid improvements in supply chains, relatively subdued demand conditions, and efforts to cut costs. Weak demand for inputs was reflected in a further contraction in purchasing activity and manufacturers continued to report an improvement in vendor performance.

On Friday, the S&P Global flash data also showed U.S. Services PMI increased to 50.8 in November from 50.6 sequentially, the highest in four months and above market expectations of 50.4 driven by companies reporting growth in customer bases following successful marketing campaigns. New business expanded for the first time in four months. However, employment moved into contractionary territory, indicating the first decline in headcounts since June 2020.

Service providers recorded faster contractions in incomplete business, primarily due to a lack of pressure on operating capacity. In terms of prices, there was a faster rise in overall selling prices, with the pace of charge inflation picking up from October's three-year low. However, expectations regarding the outlook for output over the coming 12 months became less robust. Service sector business expectations dipped to their lowest since July as firms expressed concerns about tightening customer spending and lingering economic uncertainty.

Finally, the S&P Global flash data shows U.S. Composite PMI was unchanged at 50.7 in November sequentially at a three-month high, indicating a marginal further expansion in private sector service activity. Although manufacturing firms reported a slower pace of expansion, service providers witnessed a fractional uptick in the rate of output growth, the fastest since July. Total new orders increased slightly, driven by the first expansion in service sector new business in four months, while employment levels declined for the first time in almost three-and-a-half years. On the pricing front, input costs experienced the smallest increase since October 2020 due to lower energy and raw material expenses, while selling prices advanced at a faster pace. Finally, there was a softening in business confidence.

The S&P Global comments about Nov’23 U.S. composite PMI:

“The US private sector remained in expansionary territory in November, as firms signaled another marginal rise in business activity. Moreover, demand conditions – largely driven by the service sector – improved as new orders returned to growth for the first time in four months. The upturn was historically subdued, however, amid challenges securing orders as customers remained concerned about global economic uncertainty, muted demand, and high interest rates.

Business uncertainty was also heightened among US firms, as expectations regarding the year-ahead outlook slipped to the weakest since July. Businesses cut employment for the first time in almost three-and-a-half years in response to concerns about the outlook. Job shedding has spread beyond the manufacturing sector, as services firms signaled a renewed drop in staff in November as cost savings were sought.

On a more positive note, input price inflation softened again, with cost burdens rising at the slowest rate in over three years. The impact of hikes in oil prices appears to be dissipating in the manufacturing sector, where the rate of cost inflation slowed notably. Although ticking up slightly, selling price inflation remained subdued relative to the average over the last three years and was consistent with a rate of increase close to the Fed’s 2% target.”

Overall, The U.S. has been in a manufacturing recession since Oct’22 amid higher Fed rate/borrowing costs, subdued exports after Russia-Ukraine war and slowing China. Although service activity is the backbone of the U.S. economy, after blockbuster post-COVID activities (primarily due to pent-up demand and huge COVID fiscal stimulus), the U.S. service economy is also now gradually cooling down, but core service inflation is still quite elevated due to elevated demand for services during Festival period (travel & tourism, hotel & restaurants, and shopping, etc).

Conclusion:

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 Apr’24, U.S. core CPI should be around +3.0% and then the Fed may go for rate cuts of at least -25 bps a quarter (total -75 bps in 2024) to +4.75% by Dec’24 and keep the real rate around +1.50% (compared to core CPI), still in the restrictive zone. In 2025, the Fed may further cut -1.50% for a repo rate of +3.25% against likely core CPI of around +2.00%. The market is now assuming the first Fed rate cut in June after a softer-than-expected October NFP/BLS job report. Also, Fed swaps showed more than -100 bps of easing prices for 2024!

Thus Fed is preparing the market for a hawkish hold stance in H1CY24 with an end to the current tightening cycle. Fed may go for a hawkish hold policy action/stance 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.

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%)

Fed may not hike further, keeping the terminal repo rate at +5.50% with a hawkish hold stance at least till H1CY24. Similarly, ECB and BOE will continue to be on hold with a hawkish bias at +4.75% and +5.50% respectively; i.e. we have a synchronized global hawkish hold stance by major G4 central banks (Fed, ECB, BOE, and BOC) to ensure tighter financial conditions, lower demand/economic activities and lower inflation expectations/lower inflation.

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.

Market wrap:

On Friday, US stocks closed mixed in a shortened session. The S&P 500 closed flat while the tech-savvy Nasdaq 100 dropped -0.3%, pressured by losses in mega-cap tech giants, led by Apple, Meta, and Microsoft. Also, Nvidia tumbled after a report that the company is delaying the launch of a new AI chip in China to comply with U.S. export rules. On the other hand, the Dow benefited from having less exposure to tech stocks and edged slightly above the flat line to advance +1.3% on the week, posting its fourth consecutive weekly gain, the longest streak since April. Wall Street was boosted by healthcare, energy, consumer staples, real estate, materials, banks & financials, utilities, industrials and consumer discretionary, while dragged by techs and communication services.

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

Whatever may be the narrative, technically Dow Future (35434), now has to sustain over 35400 for a further rally to 35500/35650-35850/36000 and a further 37300 in the coming days; on the other side, sustaining below 35350-35250, Dow Future may again fall to 35000-34800/34650-34120/34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (16010) now has to sustain over 16200 for a further rally to 16700-16800 zones; otherwise sustaining below 16150-16050, may again fall to around 15100-14140 in the coming days.

Also, technically Gold (XAU/USD: 2003) now has to sustain over 2015 for any further rally to 2025/2050-2065/2085; otherwise sustaining below 2010/2005-2000/1995, may further fall to 1985/1975-1960/1950 and 1928/1908-1895/1885 and 1850/1810 in the coming days (if there was a permanent Gaza war ceasefire and Fed sounds more hawkish than being expected).