Market Journal: A Parting of the Israel-Hamas Seas

A near-term positive for risk assets. Not so medium-term.

Discussion

Equities have reversed from red to green today on the news Israel’s next move may not be a ground invasion of Gaza. While in the very near-term that is certainly a positive development for risk assets (setting aside the next level thought that if not a ground invasion then what is next…?), the problem is that a parting of the Israel-Hamas seas allows rates to move higher. UST 2s are trading at new cycle highs today on a much better-than-expected retail sales report, and the entire curve has shifted up. As I’ve discussed in various forums, the fact 2s are moving higher is limiting the space for UST 30s to rise as much, so it’s not a surprise than 30s are up less than 2s. Regardless, the move up in rates in the wake of very resolute FED communication (most evidenced by FRB Philadelphia President Harker’s recent speech saying the Fed “will not tolerate a reacceleration”) says in very clear terms that a stronger economy will not be allowed to power the equity market higher into EOY. In short, equities are going to need a bigger boat than VOL market pinning and seasonality to move to new highs into EOY.

Exhibits

Equities are higher on good breadth today in the wake of Israel saying a ground incursion may not be the next step in the fight against Hamas.

The problem for equities is that a parting of the Israel-Hamas seas allows rates to move higher. UST 2s are trading at new cycle highs, the long end is moving up, and most disturbingly for risk assets in the wake of a FED resolute to fight back against a reacceleration is that TIPS break-evens are curling higher. No bueno.

This week is OPEX, so this type of move higher despite fundamentals turning more negative is not all that surprising, and part of the overall “chop” thesis as discussed in The WOTE Report this weekend. The relatively muted fall in CDXs confirms.