Risk sentiment is improved this week compared to Friday as tensions in the Middle East didn’t escalate as much as feared during the weekend. Hamas released two hostages and humanitarian aid started to enter Gaza from the Egyptian border. But tensions remain extremely high and risk of serious escalation prevails as Israel stepped up air raids in Gaza and Hezbollah could drag Lebanon into war, and spread tensions through the region.
The market has been reacting to the news mainly by seeking safety in gold. Gold spiked to $1997 per ounce on Friday on fears that tensions would further escalate in the Middle East. As the weekend news was somehow better, gold eased to $1964 on Monday morning. Upside prevails.
The next wave of haven flows will likely push the yellow metal above the $2000 mark. Above that level, we enter a little-known region. The price of an ounce reached $2075 in August 2020, tested $2070 in March 2022 at the wake of the beginning of the Ukrainian war, and the yellow metal traded at $2081 in May, this year.
The war in Gaza throws the foundation for a fresh attempt to a new high above $2080. Note, however, that as soon as tensions in the Middle East stabilize – I don’t say ease because there is a chance that we won’t see peace return to the region in the near future - gold will come under decent selling pressure as the US 10-year yield flirts with the 5% level, as the US 30-year paper now yields above 5%.
The opportunity cost of holding the non-interest bearing gold has significantly increased since the start of the war in Gaza as the negative correlation between the US yields and gold clearly broke, and turned positive. Interestingly the rising tensions didn’t benefit the US treasuries this time. The chances are that, when it is time for investors to start de-pricing the Gaza war, gold will feel like someone has pulled the rug from under its feet. But when that will happen is the million-dollar question.
Market Overview
The US Dollar Index has been stagnating since its October 3rd peak. Strong economic data, and Federal Reserve (Fed) officials’ determination to keep interest rates high for long stopped feeding into the US dollar.
Due this week, the US GDP growth is expected to double from 2.1% to 4.2% for Q3. That’s the fastest pace since the Fed started raising rates. Atlanta Fed’s GDPNow model estimate for real GDP growth (at a seasonally adjusted annual rate) in Q3 of 2023 points at 5.4% despite a more than 500BP hike since 1.5-year which didn’t bring the US economy close to a recession.
The US dollar’s reluctance faced with such a rapid rise in the yields is astonishing.
The EUR/USD tested the 1.06 offers last week, despite weakening European Central Bank (ECB) expectations. The ECB is expected to hold its rates steady when it meets this week, after a 450bp hike since last July. Christine Lagarde will unlikely call the end of policy tightening at the ECB.
She will probably remain cautiously optimistic that the ECB is also approaching the end of the tunnel, but that they must remain careful especially now that the boiling Middle East threatens to aggravate the energy crisis into another winter with limited energy supply due to the Ukrainian war.
Speaking of energy, the barrel of US crude traded past the $91pb level on Friday but smashed back below the $88pb this morning as tensions in the Middle East remained softer than what investors feared into the weekend. But upside risks prevail.
In equities, the S&P 500 closed last week more than 2.5% lower and below its 200-DMA on the back of limited risk appetite due to geopolitical tensions. Nasdaq also fell below its past year’s ascending base. The sentiment is morose, but a big wave of earnings could help equity investors price out the war news.
Amazon (NASDAQ:AMZN), Microsoft (NASDAQ:MSFT), Meta (NASDAQ:META), Intel (NASDAQ:INTC), Exxon Mobil (NYSE:XOM), and Chevron (NYSE:CVX) are among the companies that will report earnings throughout this week.