Wall Street stumbled on hotter retail sales and Gaza war tensions

On Monday, Wall Street Futures surged on hopes of an Israel-Hamas truce rather than an all-out war over Gaza; gold and US bond slips. Wall Street was also boosted by hopes of a Fed pause/pivot. On early Tuesday, Wall Street Futures got some boost, while Gold slipped on the ease of Israel-Hamas war tensions as U.S. President Biden will visit Israel and other Middle Eastern countries to resolve the geopolitical crisis and avert an all-out war. Dow Future surged to around 34304 after making an early European session low of 33961. Also expected report cards from J&J, Bank of America, and Lockheed Martin helped, while earnings missed by Goldman Sachs dragged.

But Dow Future stumbled amid hotter than expected U.S. retail sales data for September and August, which may keep the Fed on a “higher for longer stance”, although the Fed may be already on a pause/pivot mode; and may not hike further in November and December. Dow Future was also dragged on simmering geopolitical tensions as Israel allegedly bombed a civilian hospital in Gaza, killing at least 500 people. As a result, Gold got some boost and inched up to over 1931 from hotter-than-expected retail sales low around 1919. Dow Future made a low of around 34000 before closing at around 34117. On Friday, USDJPY briefly tumbled, helping Gold as BOJ may go for ‘exit’ and even hike in early 2024; BOJ may project core CPI at around +3.0% in early 2024 to pave the way for hawkish monetary policy.

Overall, Israel continues its air raids in Gaza City and the ground military exercise on the Gaza border, but till now not entered the city for various reasons. Hamas is holding around 199 hostages of Israeli, U.S. and some other foreign nationals in its deep-earth bunkers/under-earth tunnels. It seems that both Israel and U.S./NATO are continuing back-channel negotiations with Hamas for the release of the hostages and a safe passage for top Hamas leaders rather than an all-out war in Gaza. But the Israeli army may also suffer heavy casualties in Gaza City, which may have now been converted into a war trap by Hamas. Also, such an all-out war in Gaza may trigger more retaliatory actions from not only Hamas but also from Hezbollah, Iran, Syria, Jordan, Yemen and Egypt (wider conflict).

Israel is also under huge pressure from the international community including its allies for using ‘excessive’ force in Gaza. Thus Israel may prefer selective/targeted surgical strikes and military/security operations to eliminate top Hamas leaders rather than launching an all-out war to reoccupy Gaza City. Biden/U.S. and Europe/EU may also prefer this targeted surgical strike strategy rather than an all-out war, killing thousands of innocent civilians and causing more humanitarian crises. Thus the market is now focusing on Biden’s Israel tour on Wednesday for the next course of action in the Middle East.

U.S. Retail sales remain robust despite higher borrowing costs as the labor market is still hot:

On Tuesday, the CB flash data shows seasonally adjusted U.S. retail sales for Sep’23 were around $704.881B vs. 699.882B sequentially (+0.7%) and 680.387B yearly (+3.6%); i.e. the U.S. retail sales grew +0.7% sequentially in Sep’23’23, against an upwardly revised +0.8% rise in Aug’23, and above market consensus +0.3% increase.

In September, U.S. sequential retail sales at miscellaneous store retailers recorded the biggest increase (+3%), followed by non-store/online retailers (+1.1%), motor vehicles and parts dealers (+1%), and gasoline stations (0.9%). Other increases were also seen in sales at food services & drinking places (+0.9%); health & personal care stores (+0.8%); food & beverage stores (+0.4%); and general merchandise stores (+0.4%). On the other hand, sales were flat at furniture stores and sporting goods, hobby, musical instrument, & book stores and fell for electronics & appliances (-0.8%); clothing stores (-0.8%) and building material & garden equipment (-0.2%). Excluding autos, gas, building materials and food services, U.S. core retail sales rose a robust 0.6% (Forecast 0.2%, Previous 0.6%, Revised 0.3%).

Overall, the average retail sales are now around $691.734B in 2023 against the 2022 average of $672.675B in 2022, growing around +3.2% annually. The US retail sales nominal growth is still robust despite higher borrowing costs and hotter inflation (higher cost of living) as the labor market is still hot.

Although underlying retail sales are robust, adjusted headline inflation (CPI), the real retail sales are almost flat in 2023 (YTM) against +1.4% growth in 2022 (y/y). Overall, U.S. real retail sales growth is moderating, but still hot enough for the Fed’s ‘higher for longer’ stance to contain inflation without causing an all-out recession (hard landing).

Conclusion:

Fed may go for a hawkish hold policy action/stance on 1st November 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 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.

Market wrap:

On Tuesday, Wall Street Futures were almost flat, while US bond yield jumped to over +4.8% on hotter-than-expected US retail sales and subdued demand for US debts. Gold edged up on Israel-Hamas tensions; Dow slumped. Moreover, the Nasdaq was dragged as the U.S. put more restrictions on AI chip exports to China; Nvidia tumbled.

On Tuesday, Wall Street was boosted by materials, energy, financials, consumer staples, communication services, industrials, and consumer discretionary, while dragged by techs, real estate (higher bond yields), utilities, and healthcare to some extent.

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

Whatever may be the narrative, technically Dow Future (34135) 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 (15241) 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: 1919) 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 (86.35) 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.