Stocks gained, and bonds fell yesterday on US and allies’ efforts to de-escalate tensions in the Middle East. Yet Israel told the US ‘to embrace for a long war’.
We know that no matter how bad the situation gets in the Middle East, the way, and the intensity with which the market perceives the news will gradually decrease, and risk assets like gold and Swiss franc will eventually give back gains. But, right now, it is still too early to lower one’s guard, as Israel hasn’t said its last word yet. The risk of an Israeli offensive remains high, and there is a strong possibility of a sharp decline in appetite if diplomatic efforts fail.
From a price perspective, gold remains in ambush a touch lower than its 200-DMA and could rapidly jump to and above the $2000 per ounce mark in case of further bad news from the Middle East. The US 10-year yield could quickly snap back to 4.50%, and oil could hop. Yesterday, the overall market relief led oil prices lower. News that the US and Venezuela are set to resume talks with a strong potential for Biden administration to ease sanctions against the Venezuelan oil helped. But upside risks prevail. Iranian implication in tensions could send the barrel of oil above $100pb.
A Risky Place
The Gaza situation is not helping to improve relations between the US and China since China picked the Palestinian side in the conflict. Therefore, it’s little surprising that the US considers further curbs on China’s access to advanced semiconductors, or to machines that build advanced semiconductors, if nothing, to make sure that China doesn’t get the cutting-edge technology available for its military. Nvidia (NASDAQ:NVDA) gained yesterday despite the news, but chip stocks are a risky place, not only due to a potentially escalating chip war between the US and China, but also because, Israel plays an important role in the production of advanced chips, and tensions in Israel could further disturb the global supply chain for chips.
Data Watch: Strong US Retail Sales Could Boost Appetite if Fed Rate Expectations Remain Contained.
A potential return to low-risk assets could boost demand in US sovereigns in the short run, but the faith of US bonds is also tied to the economic data and what the Federal Reserve (Fed) will, or will not do in the coming meetings in the context of its own war against inflation. It’s clear that a further escalation of tensions in Gaza, and a sustainable positive pressure in oil prices should boost inflation expectations and fuel rate hike bets for the year end. However, no more hikes remains the base case scenario for now.
On the data front, the Empire Manufacturing index showed a slower-than-expected contraction in October, and the retail sales data for September will be released today. The number could be a strong one, given that September tends to be a good month for spending as children return to school. Strong data could fuel optimism if Fed speakers continue to hint at the end of monetary policy tightening. Note that strong US spending has been one major pillar that explains why the US economy remained so resilient to the Fed’s aggressive tightening campaign. But behind the curtains, we see important vulnerability. The IMF data shows that, unlike some European nations including Germany, France, and the UK, American savings took a very severe dive to pre-pandemic levels. And now that money is becoming rare, spending should slow, and help the Fed keep inflation on track towards its 2% target.