Month: December 2023

By Michael Every of Rabobank

Two Ronnies in a Packed Programme Tonight

The market is having second thoughts. Wisely so, as there are many ways to interpret what we see and hear. In a classic Two Ronnies sketch, “fork handles” is heard as “four candles”. In the same way, markets are hearing “rate cuts” as the Fed says “rates up”. Market cheerleaders need to understand the difference between disinflation (i.e., your rent went up 20% last year, and is going up 5% this year) and deflation (i.e., your rent goes down 10%). The latter is the prerequisite for the imminent slashing of rates we are now seeing priced in.

In reality the US labor market remains tight, as Friday’s payrolls are likely to show, and a court just ruled gig food-delivery jobs must pay a minimum of $17.96 an hour. US construction spending is holding up, and most households aren’t experiencing the pain of higher mortgage rates without moving – so they aren’t. While the market focuses on the ISM, Freight Alley notes: “when you see a development in both container and trucking datasets, it suggests that something macro is happening. That is what I am seeing in container and trucking. YoY volume comps in both datasets both inflected in recent months, suggesting that inventories have burned off and the goods economy recovery may be on the way.” All this is as US core sticky inflation ticks up on a 3-month annualised rate; the NFIB small businesses’ ‘plans to raise prices’ are heading up; Michigan consumer inflation expectations have spiked; and we just experienced the largest easing in financial conditions in decades, seeing speculation roar back.

Yes, look at four candles on charts: but handle needing to stick a fork in this bond rally, because it’s overdone.

To think otherwise is to believe the Fed is willing to repeat the ‘cut-first’ errors of the 2010s, 2000s, 1990s, and the 1980s, and the ‘ignore inflation’ error of the 1970s. Maybe that is the trend to follow; but it would make Powell quite the Mastermind, another classic Two Ronnies sketch, in which the contestant answers the question before last each time.

MAGNUS: And so to our final contender. Your name, please?

SMITHERS: Good evening.

MAGNUS: Thank you. In the first heat your chosen subject was Answering Questions Before They Were Asked. This time you have chosen to Answer the Question Before Last each time. Is that correct?

SMITHERS: Charlie Smithers.

MAGNUS: And your time starts now. What is palaeontology?

SMITHERS: Yes, absolutely correct.

MAGNUS: Correct. What is the name of the directory that lists members of the peerage?

SMITHERS: A study of old fossils.

MAGNUS: Correct. Who are David Owen and Sir Geoffrey Howe?

SMITHERS: Burke’s.

Are the Fed really going to be fossilized berks in trying to fight the ‘deflationary crisis’ before last when we now face structural, geopolitical inflation?

Yes, oil continues to fall despite promised OPEC+ cuts, protestations that the Saudis can’t afford their linear city, year-round ski resort, and new footballers, and the US DOE wanting to buy “as much oil as it possibly can” for the SPR. Yet the oil-price is the Fed winning the battle of the dollar vs. commodities via higher rates. There is no geopolitical/geoeconomic room for it to slash rates: and that geopolitical backdrop is easy to interpret, and isn’t funny, even if it sounds like a Two Ronnies newsreader skit in the recent headline: ‘Miss Universe winner claimed to be at centre of alleged plot to overthrow Nicaraguan government’.

North America:

• The US is admitting it can’t match military production with rival ‘arsenals of autocracy’. Markets still don’t grasp the enormity of what a failing US hegemon means.
• A former US ambassador and National Security Council official has been charged with secretly acting as an agent of the Cuban government. One wonders how many more will follow.

Europe:

• The US says money for Ukraine runs out at the end of the year, and the EU might leave Ukraine without any support as soon as next week. So much for the West’s ‘whatever it takes’ to save the liberal world order? The ramifications are enormous, if so.
• The Polish security chief says NATO’s eastern states have three years to prepare for a Russia attack: others say five to ten. Nobody says we should slash military spending.

Middle East:

• A COP28 headed by a massive fossil fuel producer is –shockingly– in favour of massive fossil fuel production, suggesting a deeper split between the West and the Middle East.
• Israel is moving against Hamas in south Gaza. Although Hezbollah has so far restrained itself, tensions are high, and Israeli Defence Minister Gallant was allegedly blocked from attacking it first given his view that fighting a two-front war should begin with the more dangerous enemy. It still seems unlikely Jerusalem –which has strategically shifted to assuming its enemies will act, rather than seeing their forces as just a deterrent– will be held back vs. Hezbollah or Iran in the long term by US concerns over regional escalation. Indeed, Israel killed two Iran Revolutionary Guards Council generals in Syria in a recent airstrike, for which Iran has vowed revenge.
• There might have been insider trading of the 10/7 Hamas attack on Israel, which raises some awkward questions of who knew what and when.
• Iran-backed Houthis have attacked more commercial shipping and the US Navy around the Bab-el-Mandeb, the Red Sea chokepoint one cannot avoid when using the Suez Canal.
• Turkey has warned Israel not to assassinate Hamas leaders based there, perhaps prompting some to ask why Hamas leaders are openly present in a NATO member.

Latin America:

• Venezuela held a referendum on annexing Essequibo, a huge oil-rich swathe of neighbouring Guyana, with a 97.5% positive vote (the other 2.5% go “right to jail”). Venezuela is not in a position to do much about it now: but should its economy recover, it would be, and again the world is seeing countries move lines on maps to control key commodities.
• Hal Brands argues the US must revive the 200-year old Monroe Doctrine to ensure its security.

Asia:

• China ripped US Commerce Secretary Raimondo for calling it an “enemy”: but what does China say domestically about the US and the outlook for liberal democracy and capitalism?
• Australia has signed a visiting forces agreement with France. From AUKUS to FAUKUS?

In short, if you think that’s all deflationary then you haven’t read history. Or you watch ‘news’ like this.

It’s goodnight from me. And it’s goodnight from him.    

Following weakness in the Manufacturing survey data, Services surveys were expected rebound in November, despite the plunge in ‘hard’ data seen in November.

S&P Global’s Services PMI ticked up in November to 50.8 from 50.6 in October (flat from the flash print)

ISM’s Services PMI beat expectations, rising from 51.8 to 52.7 (vs 52.3 exp) in November.

Source: Bloomberg

Under the hood, Employment rose less than expected; New Orders were flat ; and Prices Paid declined…

Source: Bloomberg

“Fifteen industries reported growth in November,” noted Anthony Nieves, Chair of the ISM Services Survey Committee.

“The Services PMI, by being above 50 percent for the 11th month after a single month of contraction and a prior 30-month period of expansion, continues to indicate sustained growth for the sector, and at a slightly faster rate in November.”

Manufacturing continues to contract according to both surveys while Services expand…

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, said:

“The latest PMI data point to a further cooling of inflation pressures, but the surveys also signal only modest economic growth and near-stagnant employment, with the risk of the expansion losing further momentum as we head towards 2024.

“While service sector businesses continued to report further output gains in November, growth remains considerably weaker than seen earlier in the year, and forward-looking indicators point to growth slowing in the months ahead.

“Firms providing both goods and services have become increasingly concerned about excessive staffing levels in the face of weakened demand, resulting in the smallest overall jobs gain recorded by the survey since the early pandemic lockdowns of 2020.

But there is some good news:

“The cooling jobs market has been accompanied by lower wage growth which, combined with recent oil price falls, helped pull business cost growth down to its lowest for three years, dropping in November to a level indicative of inflation approaching The Fed’s 2% target in the coming months.”

Is that good enough to keep the dream alive for 125bps of rate-cuts next year?

The smooth road the world has travelled on since the Great Financial Crisis, with stable geopolitics, low inflation and low interest rates, was disrupted during the pandemic years, with policymakers and investors betting on a return to the ‘old normal’.

In 2024, Saxo warns that it will become clear that the smooth road is at an end, sending the world into a dangerously uncertain future.

Saxo CIO Steen Jakobsen sees the world at an inflection point and their 2024 Outrageous Predictions look at how the world navigates the ultimate end of the ‘old normal’, and how new technologies solve old problems, while creating new, maybe more dangerous dilemmas.

1. With oil at $150, Saudis buy Champions League franchise

As oil prices soar, Saudi Arabia extends its influence by acquiring one of the most coveted franchises in sports to create a World Champions League:

“Saudi Arabia’s radical restructuring of its economy away from its dependency on oil revenues towards becoming a tourism, leisure, and entertainment powerhouse, receives an added boost from a meteoric rise in oil prices, which reach $150 per barrel around mid-year on stronger-than-expected demand. Now holding the keys to the cherished football competition, the Saudis immediately move to transform it into a global club competition.”

The Manchester United stock price doubles and Brent crude goes to $150 per barrel.

2. World hit by major health crisis as obesity drugs make people stop exercising

GLP-1 obesity drugs are seen as a solution to the world’s obesity epidemic, but the ease of taking a pill makes people stop exercising and increase their intake of junk food:

“As supply of GLP-1 obesity drugs is expanded, prices come down and governments choose to designate the obesity drugs as vital for improving health and stopping the obesity epidemic…However, in a turn of events, supply of GLP-1 obesity drugs is unable to meet the widespread demand, and patients need to wait for years to get their injections. Meanwhile, they stop exercising or keeping to a healthy diet now that a pill can keep weight in check, fuelling a major health crisis. Global adult obesity rates shoot up from the current 39% to 45% in 2024.”

The processed food industry sees a significant demand lift, McDonalds and Coca-Cola stock prices outperform broader markets by 60% each.

3. US heralds the end of capitalism with tax-free government bonds

The US adopts a radical fiscal strategy to tackle its economic challenges by incentivizing investment in government bonds.

“The US government is forced to increase fiscal spending exponentially amid the 2024 elections to keep the economy going and avoid social unrest. Due to lingering inflation pressures and foreign investors repatriating capital, demand for US Treasuries remains sluggish, provoking a spike in US Treasury yields. In a desperate attempt to normalise borrowing costs, the US government makes income from government bonds tax-free.”

US Treasuries rally across all tenors, and the yield curve bull-flattens as investors can lock in the highest yields in decades without tax burdens. The stock market tumbles, but a selected group of cash-rich companies benefit from an inverted yield curve.

4. Generative AI deepfake triggers a national security crisis

Generative AI, hailed as a productivity boon, becomes a national security threat after a daring AI deepfake heist against a high-ranking official in a developed country. Governments crack down on AI with new regulations, puncturing the AI hype as VCs flee the industry:

“In a high-stakes game, a criminal group deploys the most deceptive generative AI deepfake the world has ever seen, phishing a high-ranking government official to hand over top-secret state information from a developed country. The daring move and success trigger the biggest national security crisis since WWII, ushering in a new era of far-reaching AI regulation. In a historic move to deal with the catastrophic side effects of generative AI, the US and EU declare that all content produced by a generative AI should have the label ‘Made by AI’. The generative AI deepfake incident goes from national security crisis to full-blown public distrust in information delivered on the Internet, as AI-produced content swells to 90% of all information.”

Traditional media companies approved by their governments for disseminating public news soar in value, with shares in The New York Times Company doubling. Adobe shares plunge as government penalises the company, as the catastrophic deepfake was made using its software.

5. Deficit countries form ‘Rome Club’ to negotiate trade terms

A coalition of deficit countries aims to restructure global trade dynamics in their favor:

“As the US debt situation has become uncontrollable, a group of six deficit countries form a ‘Rome Club’ to cooperate on reducing deficits by collectively negotiating new world trade terms with the surplus countries. The argument goes that resetting the deficits through gradual pegged revaluations of the surplus countries would enable a global reset, creating a more equal and stable economic model. The six founding countries of the ‘Rome Club’ are the US, UK, India, Brazil, Canada and France. Adjusting the divergence of the current account between the key countries is going to be a painful adjustment for the highest surplus countries which are China, Germany, Norway, Japan, the Netherlands and Singapore.”

The fact that the world’s reserve currency is spinning out of control reduces faith in the fiat money system, setting up big gains for gold, silver, and crypto currencies.

6. Robert F. Kennedy Jr wins the 2024 US presidential election

In a stunning political upset, RFK Jr. captures the presidency, ushering in a new political direction for the United States:

“In 2024, for the first time in the history of the USA, a third-party candidate, Robert F. Kennedy Jr, wins the US presidential election. His populist platform against the war-mongering Democrats and against the corporate elites resonates with both disgruntled traditional Democratic and Trump supporters. A new political era in the USA begins with the dramatic pivot away from plutocracy, as voters demand an end to drastic inequality and injustice and the end of forever wars.”

Kennedy’s pro-peace message and promise to end the abuses of the US healthcare system and break up excess corporate power sees defense, drug and healthcare companies nosedive, and the internet and info-tech monopolies trade nervously on concerns that a wider war against monopoly companies will follow.

7. Japan’s ‘lucky 7%’ GDP growth rate forces BoJ to abandon yield curve control

Japan experiences a surprising economic surge, leading to a significant policy shift by the Bank of Japan.

“The deflation era in Japan has ended, bringing wage growth back. With a yield curve control policy in place, the Japanese economy is over-stimulated as real rates decline with nominal yields capped but inflation expectations rising. The BoJ is therefore forced to end its yield curve control policy in 2024. This causes a rout in global bond markets, as Japanese investors move money back home.”

Yen strengthens as Japanese investors repatriate money to domestic assets, pushing USDJPY below 130, EURJPY below 140 and AUDJPY below 88.

8. Luxury plunges as EU goes Robin Hood, introducing wealth tax

The European Union’s new wealth tax leads to a downturn in the luxury market, with major repercussions for high-end brands:

“It is a great irony that the EU, which is the world’s biggest welfare system, has created 499 USD billionaires who are paying the lowest amount of personal tax in percentage of wealth compared to billionaires from North America and East Asia.

As social unrest in Europe is constantly at the edge of eruption, and as costs associated with the green transformation, the war in Ukraine and general inflation rise, the EU Commission commits to the July 2023 European Citizens’ Initiative (ECI) entitled ‘Taxing great wealth to finance the ecological and social transition’.

The EU Commission implements a law that annually taxes 2% of wealth on billionaires. This modern version of Robin Hood sends shockwaves through the European luxury industry, as recent studies have shown a strong correlation between the pursuit of luxury items and levels of income and wealth inequality.”

LVMH shares plunge 40% on the EU Commission’s new wealth tax and other parts of the luxury segment including Porsche and Ferrari see their share price suffering badly.

Though these predictions are not Saxo Bank’s official market forecasts, they are a reminder to investors to consider all potential outcomes, including those that seem far-fetched.

Outrageous Predictions are a deliberate effort to push the boundaries of market participants’ imaginations and prepare them for any eventuality.

Finally, while these predictions may seem ‘outrageous’, some have been much closer to the truth than anticipated:

2023 honourable mention: A country agrees to ban all meat production by 2030

Reviewing last year’s predictions, it’s evident that they were more outrageous than they were correct. A fan favourite was Market Strategist Charu Chanana’s prediction about a country agreeing to ban all meat production by 2030. It didn’t turn out that way and it would be a stretch to say that it was close. But, at a supranational level, meat, as an important part of fighting climate change, was spotted on the agenda at the UN-arranged climate change-focused COP28 in the latter part of the year. Here, the UN was, in time of writing, expected to publish a road map for global food systems with a focus on lowering meat consumption.

“While we didn’t see any country banning meat production, we did see a growing recognition that meat (and the consumption of it) needs to be in focus when talking about climate change. So, picking a topic that turns out to get attention and taking it a step further than reality is really what this exercise is about,” says Chanana.

2022 Outrageous Prediction: The plan to end fossil fuels gets a rain check

As we headed into 2022, Ole S. Hansen, Head of Commodity Strategy, wrote that policymakers would kick climate targets down the road and support fossil fuel investment to fight inflation and the risk of social unrest, while rethinking the path to a low-carbon future.

The overarching prediction came to fruition, but it was regrettably fueled by the unforeseen invasion of Ukraine by Russia.

“Little did we know last November that the world was galloping into an energy crisis triggered by Russia’s war in Ukraine,” says Ole S. Hansen, Head of Commodity Strategy, who explains how he then caught on to the idea that fossil fuels would become relevant again in 2022: “Lack of investments and an increasingly urgent need to support gas over coal led us to come up with this idea, which basically envisaged a more investor friendly environment for (up until then) shamed investment in so-called ‘dirty’ energy production.  A move that led to the decision by the EU to classify gas and nuclear as green investments,” he says.

2018 Outrageous Prediction: Volatility spikes after flash crash in stock markets

“We did not get a 25% drop in a single 1987-like event, but we did get two dramatic events in 2018 that vindicated our point,” says Peter Garnry, Head of SaxoStrats.

He further explains how the prediction came about: “We got the idea about this Outrageous Prediction in late 2017, as the year was about to end with astonishingly low volatility and Bitcoin had gone from just below $1,000 in late 2016 to around USD 10,000 in November 2017 (Bitcoin eventually rose to almost USD 20,000 before year end). Everyone speculated in Bitcoin and selling volatility in currencies and equities was heralded as easy predictable money. That’s where we got this super awkward feeling that the entire euphoria and these types of positions can have dramatic outcomes if conditions change even the slightest.”

Garnry says that the volatility kicked in during February and ended in dramatic fashion over Christmas: “The ‘Volmageddon’ event in February 2018 almost completely wiped out short volatility funds including some famous ETFs in these strategies as the VIX Index exploded from 13.64 to 50.30 in just two trading sessions. The event changed the short volatility complex in the subsequent years. Later in 2018, the market was trying to tell the Fed that it was doing a policy mistake by hiking its policy rates because the economy was deteriorating. It led to a selloff of 20% from the peak in October to the intraday bottom on 26 December 2018 with the most dramatic trading sessions happening over the Christmas holiday period when liquidity was drying up. Dramatic events that set the stage for the crazy bull-run in 2019 as investors again forgot everything about risk.”

2017 Outrageous Prediction: Huge gains for Bitcoin as the cryptocurrencies rise

As cryptocurrencies, particularly Bitcoin, began gathering momentum in the public eye, our SaxoStrats predicted that the then leading currency would have a huge bump in value. The rationale behind the jump was justified by US President Donald Trump’s regime overspending, causing national debt to rise and inflation to skyrocket. Combining this with the global public wanting to break away from the currencies of central banks, Bitcoin became a preferred alternative. The Outrageous Prediction ended up coming to fruition and more, with the price of Bitcoin growing to almost USD 20,000 at its 2017 peak.

However, the circumstances around the prediction weren’t spot on. It wasn’t as much due to macroeconomic movements of the Trump era, as it was due to speculation in Bitcoin that fueled its initial meteoric rise. However, when looking at the more recent spikes in cryptocurrencies, particularly Bitcoin in 2021, the justifications outlined in the 2017 Outrageous Prediction held true.

2015 Outrageous Prediction: Brexit in 2017

In the Outrageous Predictions for 2015, our SaxoStrats wrote that the UK Independence Party (UKIP) would win 25% of the national vote in Britain’s general election on 7 May, 2015, sensationally becoming the third largest party in parliament. UKIP would then join David Cameron’s Conservatives in a coalition government and call for the planned referendum on Britain’s membership of the EU in 2017. As a result, UK government debt suffers a sharp rise in yields.

The timing was a bit off, but the circumstances around it were pretty accurate. “We had a very strong sense that ‘protest votes’ would be coming both in the US election and also ultimately in a vote on Brexit” said Steen Jakobsen, CIO at Saxo. “We, to some extent, correctly talked about the ‘social-contract being broken’ – meaning society no longer benefitted as a whole from monetary policy, which created an increased gap in equality.

“This call was too early, but the context and reasoning was spot on. The split in the Tory Party could not be healed and the modus operandi of ‘Talking down to the voters’ was a blatant mistake, which we used for this call,” Jakobsen said.

2013 Outrageous Prediction: Gold corrects to USD 1,200 per ounce

“Our $1,200 call, at the time of writing, signaled a one-third drop in the price,” says Head of Commodity Strategy, Ole S. Hansen who, in 2013, had the first correct Outrageous Prediction.

Here’s what he had to say about it: “Gold corrected to and actually went below USD 1,200 per ounce in 2013, as investors increasingly turned their attention to stocks and the dollar. A major trigger was the April 2013 break below key support at $1,525 – a move that in our mind raised the risk of a bear market taking the price down towards $1,100,” says Hansen.

So how many of this year’s “predictions” will come true next year?

Authored by Simon White, Bloomberg macro strategist,

Expectations of rate cuts in the US are liable to come unstuck as easing financial conditions raise the risk the Federal Reserve returns to the fold with another hike…

Be careful what you wish for.

The market’s increasing zeal for lower rates has rekindled the so-called everything rally. But if it persists it contains the seeds of its own destruction as it ultimately pushes the Fed to recommence raising rates, wrongfooting growing expectations of rate cuts, and leaves stocks and bonds prone to selling off.

Since the Fed started tightening policy in June last year, the S&P is ~20% higher, credit spreads are tighter, implied equity and fixed-income volatility are lower and reserves have risen. Animal spirits have not exactly been deterred.

Central banks face the perennial problem of “time inconsistency”. This is the paradox that the optimal policy for a central bank at the current time may not be the optimal policy later. For instance, a central bank may promise in the future to raise rates to curb inflation. Market rates rise, conditions tighten, unemployment rises and inflation starts to fall. The bank is then in the position of having to raise rates when the labor market is weakening, or risk damaging its credibility.

Today, it may be optimal for the Fed to start countenancing rate cuts as it appears (to the Fed) that inflation is back under control. However, this blunts the totality of its policy rate’s impact across markets and the economy, raising the risk of a re-acceleration in inflation.

To see this, financial conditions are an obvious place to start.

The Fed has frequently cited them as one of the metrics it deems as important to gauge if policy is working.

“Key for policy is persistence of easing in financial conditions,” president of the New York Fed John Williams stated in a speech only last week.

Most indexes of financial conditions are composed of stock prices, implied volatility, credit spreads and credit standards.

The rally this last month across assets has thus loosened financial conditions. This is actually quite normal after the Fed’s last hike, as can be seen in the chart below.

The key question is whether conditions will eventually ease enough to bring the Fed back to the table with another rise in rates?

Given generally still-favorable liquidity conditions that are supportive of risk assets, the odds are heading in that direction.

First, both prongs of Fed policy – quantitative tightening and the level of rates – are now tempering financial conditions rather than tightening them.

With QT, Fed reserves have been rising, despite the ongoing contraction in the Fed’s balance sheet. As discussed last week, November saw a jump in Fed reserves by ~$200 billion.

The dynamics of the Fed’s balance sheet – specifically money market funds drawing down on excess liquidity in the reverse repo facility (RRP) and the Treasury’s preference for issuing bills – have meant that reserves are being on net added to the system, supporting asset prices.

With the RRP still at ~$1.25 trillion and the next Quarterly Refunding Announcement — where the Treasury could indicate it is skewing issuance away from bills again — not until late January, there are no signs this supportive backdrop will alter in the near future (although we have seen a short-term dip in liquidity over the past week).

Also, the Fed’s policy rate is becoming less restrictive. The neutral rate, r*, is unobservable and estimates are released with a lag. But we can get a real-time indication of how restrictive the Fed’s rate is by looking at the yield curve. As the chart below shows, the difference between real fed funds and r* (i.e. the degree of restrictiveness in the rate) is analogous to the 3m versus 10y curve.

The steepening of the yield curve is telling us that even though the Fed has not yet cut the policy rate, it is nonetheless becoming less restrictive.

Global liquidity conditions are also easing, which will provide a further support to US assets, especially as the dollar continues to weaken. The Global Financial Tightness Indicator (GFTI) is a diffusion of central-bank rate hikes and has been rising – indicating easing conditions – as fewer central banks are hiking and some are cutting.

The Advanced Global Financial Tightness Index (the AGFTI; brown line in the chart below) uses central-bank rate expectations to lead the GFTI by about six months. As we can see, less hawkish central banks are boosting the AGFTI, pointing to the GFTI (black line in chart) continuing to rise also; i.e. financial conditions should keep easing.

Moreover, as discussed in last Tuesday’s column, excess liquidity also continues to rise, which is very supportive for risk assets over the medium term.

It’s been over four months since the Fed last hiked rates, and the market expects the next move to be a cut. History is on its side: it would be unprecedented for the Fed to re-start a hiking cycle after so long when rates are restrictive.

But not so if the rate is unrestrictive (i.e. it is less than r*), with the Fed recommencing hikes after a long pause on several occasions (1973, 1977, 2016 and 2017). The steepening of the yield curve or a re-rise in inflation (as I expect) would both indicate the Fed’s rate is losing its bite.

Liquidity conditions are such that risk assets keep can keep grinding higher, emboldening yet more speculative behavior antithetical to the desire to rein in animal spirits, increase risk premia and thus keep inflation contained.

The likelihood is rising the Fed – haunted by the ghost of Arthur Burns – will feel compelled to push against the market and raise rates again.

Israel’s military has reportedly put in place controversial and high risk plans to flood Gaza’s vast network of underground tunnels used by Hamas with sea water. High powered pumps have already been set up at key locations in the Gaza Strip.

The plan is to force Hamas militants above ground or else drown them, utilizing a series of pumps to pull water from the Mediterranean Sea, which are expected to provide enough water to fully flood the tunnels within weeks. According to details in The Wall Street Journal, US defense officials have been briefed on the ‘option’ – and with pumps now in place – but it’s not believed that the Israelis have pulled the trigger on it yet. 

“The Israel Defense Forces finished assembling large seawater pumps roughly one mile north of the Al-Shati refugee camp around the middle of last month,” the report indicates. “Each of at least five pumps can draw water from the Mediterranean Sea and move thousands of cubic meters of water per hour into the tunnels, flooding them within weeks.”

Some US officials were cited as expressing “concern” about the plan, also given the potential to kill more civilians and further destroy the Strip’s infrastructure. A prime issue is that some 137 Israeli and foreign hostages remain in Hamas captivity after the end of last week’s ceasefire and prisoner swap deal. 

Very likely all or many of them are being kept somewhere within the tunnel system and its cavernous rooms. Hamas even has subterranean offices and command centers within. Israel has thus far identified at least 800 tunnels, but believes the network is still much bigger than what’s known.

“We are not sure how successful pumping will be since nobody knows the details of the tunnels and the ground around them,” one unnamed security source told the WSJ. “It’s impossible to know if that will be effective because we don’t know how seawater will drain in tunnels no one has been in before.”

There’s also the question of the seawater destroying altogether what’s left of the Strip’s already damaged water system, which draws on Gaza’s increasingly saltier aquifer. The whole flooding initiative could also bring down more buildings or entire blocks, making the place uninhabitable for years to come. 

“Wim Zwijnenburg, who has studied the impact of war on the environment in the Middle East, said that assuming that about one-third of the tunnel network is already damaged, Israel would have to pump roughly 1 million cubic meters of seawater to disable the rest,” the WSJ report notes.

The IDF plans to pump seawater into Hamas’ network of tunnels in the Gaza Strip. With more on this subject, our correspondent in Israel, Diana Skaya. pic.twitter.com/VRbv9Wp16s

— TVP World (@TVPWorld_com) December 5, 2023

Last week, Secretary of State Antony Blinken was in Israel where he pressed for a “clear plan in place that puts a premium on protecting civilians.” But if Israel ‘gets creative’ with these daring plans to flood the tunnels, this will bring even more pressure to bear on the White House internationally to condemn or reign in the IDF.

While President Biden has been personally relatively quiet on the issue, his security officials as well as Vice President Harris have been increasingly vocal on the need to protect civilians.

A month ago there were wild reports and speculations that Israel could pump Sarin gas or other chemical weapons into the tunnels. However, this is unlikely to have ever been a real option given the unpredictable nature and potential spread of nerve agents to confines not intended to be targeted (such as civilian homes, hospitals and buildings above the tunnels).

By Michael Msika, Bloomberg Markets Live reporter and strategist

Warnings are piling up that the market is overheating, but “don’t fight the tape” seems to be the motto now in this last stretch of the year.

The market continues its grind higher after a stellar performance in November for bonds and stocks. With December typically a good month for stocks, it seems no one wants to be short or bet that things will get shaky. If anything, there’s just a bit of hedging or rotation going on.

“Given that dealers are still positioned in positive gamma, there appears to be no immediate catalyst to disrupt the ongoing low-volatility environment,” say Tier1Alpha strategists.

“If the S&P 500 begins to trend lower, market makers will have to mechanically buy the dip. Conversely, if the market trends higher, dealers will have to sell futures in order to maintain a delta-neutral position.”

The rally has broadened, taking the Stoxx 600 technical breadth to levels that typically warrant a pause, if not a retracement. Not only is the benchmark is now overbought based on the relative strength index (RSI), but the proportion of overbought members is the highest since February, exceeding 20%.

“The bounce is a squeeze,” say UBS strategists led by Gerry Fowler, who see the November surge as being driven by technical factors. “CTAs were short but have now closed 80% of their position. Investors had become short a range of unloved stocks and were squeezed out of positions.”

The strategists still expect that the highly anticipated slowdown and equity weakness are coming but it could be like an “escalator down” – slow.

Last week, surprisingly strong US GDP data as well as stabilizing flash PMIs in Europe were additional reasons to embrace the soft-landing narrative. Nevertheless, while economic surprises are showing improvement in Europe, they’re still negative, while the US equivalent is on a downward slope, possibly a bad medium-term omen for stocks.

Yet, that may not be enough to stop the market’s ascent, especially as central banks are turning increasingly dovish. Citigroup strategists led by Beata Manthey, who see around 10% upside for European stocks next year, expect an “improving balance of risks.”

“Rates/inflation are falling, geopolitical risks have abated, and European PMIs have likely bottomed,” they say. “This points to rising chances of economic ‘soft landing’ scenarios and potentially expedited policy easing.”

“We stay bullish into year end, appreciating the fact the set up — positioning, technicals, sentiment, year-to-date performance — is very different compared to where it was this time last month,” says Carl Dooley, head of EMEA trading at TD Cowen.