Dow and gold surged on Powell Put after a roller coaster move

·         Although Powell indicated rate cuts as the next move, Sep’24 is not a done deal till the evaluation of Aug’24 job and inflation data

·         On Friday (Jackson Hole), Powell didn’t say anything new, which the market does not know already

·         The market is already almost discounted for the next Fed rate cut cycle of -275 bps over the next 11 QTRs either from Dec’24 or Sep’24

·         Fed rate cuts cycle often coincided with some types of global financial crisis; at around 5700-5800, the TTM PE of SPX-500 is over 30 bubble zone

On Thursday, Wall Street Futures were almost flat on lingering suspense about an early Fed pivot and Gaza war ceasefire. Latest FOMC minutes and Fed talks indicate that the Fed is ready to start cutting rates from Serp’24 provided economic data in totality supports the Fed’s much-needed confidence and for that Fed may watch August employment and core inflation data closely before taking any rate cut action. If August job/employment data comes as ‘terrible’ / mixed as July, while core inflation eased by another 0.10/0.20% in August, then the Fed may launch the 11-QTR rate cuts cycle from Sep’24 QTR; otherwise, it may want to observe more data (at least Sep-Oct-Nov’24) before launching the much-awaited rate cut cycle from Dec’24 QTR.

On Friday, all focus of the market was on Fed Chair Powell’s speech at the annual symposium at Jackson Hole. Powell said:

·         The time has come for policy to adjust

·         The timing and pace of rate cuts will depend on incoming data, outlook, and the balance of risks

·         We do not seek or welcome further cooling in labor market conditions

·         We will do everything we can to support a strong labor market as we make further progress toward price stability

·         The balance of risks to our mandates has changed. Upside risks to inflation have diminished, and downside risks to employment have increased

·         Inflation has declined significantly, we're now much closer to the goal

·         We have made a good deal of progress toward the goal of price stability while avoiding sharp increases in unemployment

·         The labor market cooling is unmistakable, we're no longer overheated

·         My confidence has grown that inflation is on a sustainable path back to 2%

·         Now policy rate level gives ample room to respond to risks, including unwelcome further weakening in the labor market

·         Fed has made a good deal of progress towards a soft landing; i.e. restoring price stability and maintaining a strong labor market

Full text of Fed Chair Powell’s speech at Jackson Hole

August 23, 2024: Review and Outlook: Chair Jerome H. Powell

At “Reassessing the Effectiveness and Transmission of Monetary Policy,” an economic symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming

 “Four and a half years after COVID-19's arrival, the worst of the pandemic-related economic distortions are fading. Inflation has declined significantly. The labor market is no longer overheated, and conditions are now less tight than those that prevailed before the pandemic. Supply constraints have normalized. And the balance of the risks to our two mandates has changed. Our objective has been to restore price stability while maintaining a strong labor market, avoiding the sharp increases in unemployment that characterized earlier disinflationary episodes when inflation expectations were less well anchored. We have made a good deal of progress toward that outcome. While the task is not complete, we have made a good deal of progress toward that outcome.

Today, I will begin by addressing the current economic situation and the path ahead for monetary policy. I will then turn to a discussion of economic events since the pandemic arrived, exploring why inflation rose to levels not seen in a generation, and why it has fallen so much while unemployment has remained low.

Near-Term Outlook for Policy

Let's begin with the current situation and the near-term outlook for policy.

For much of the past three years, inflation ran well above our 2 percent goal, and labor market conditions were extremely tight. The Federal Open Market Committee's (FOMC) primary focus has been on bringing down inflation, and appropriately so. Before this episode, most Americans alive today had not experienced the pain of high inflation for a sustained period. Inflation brought substantial hardship, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. High inflation triggered stress and a sense of unfairness that linger today.

Our restrictive monetary policy helped restore balance between aggregate supply and demand, easing inflationary pressures and ensuring that inflation expectations remained well anchored. Inflation is now much closer to our objective, with prices having risen 2.5 percent over the past 12 months. After a pause earlier this year, progress toward our 2 percent objective has resumed. My confidence has grown that inflation is on a sustainable path back to 2 percent.

Turning to employment, in the years just before the pandemic, we saw the significant benefits to society that can come from a long period of strong labor market conditions: low unemployment, high participation, historically low racial employment gaps, and, with inflation low and stable, healthy real wage gains that were increasingly concentrated among those with lower incomes.

Today, the labor market has cooled considerably from its formerly overheated state. The unemployment rate began to rise over a year ago and is now at 4.3 percent—still low by historical standards, but almost a full percentage point above its level in early 2023. Most of that increase has come over the past six months.

So far, rising unemployment has not been the result of elevated layoffs, as is typically the case in an economic downturn. Rather, the increase mainly reflects a substantial increase in the supply of workers and a slowdown from the previously frantic pace of hiring. Even so, the cooling in labor market conditions is unmistakable. Job gains remain solid but have slowed this year.

Job vacancies have fallen, and the ratio of vacancies to unemployment has returned to its pre-pandemic range. The hiring and quitting rates are now below the levels that prevailed in 2018 and 2019. Nominal wage gains have moderated. All told, labor market conditions are now less tight than just before the pandemic in 2019—a year when inflation ran below 2 percent. It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions.

Overall, the economy continues to grow at a solid pace. However the inflation and labor market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased. As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate.

The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.

We will do everything we can to support a strong labor market as we make further progress toward price stability. With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market. The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions.

The Rise and Fall of Inflation

Let's now turn to the questions of why inflation rose, and why it has fallen so significantly even as unemployment has remained low. There is a growing body of research on these questions, and this is a good time for this discussion. It is, of course, too soon to make definitive assessments. This period will be analyzed and debated long after we are gone.

The arrival of the COVID-19 pandemic led quickly to shutdowns in economies around the world. It was a time of radical uncertainty and severe downside risks. As so often happens in times of crisis, Americans adapted and innovated. Governments responded with extraordinary force, especially in the U.S. Congress unanimously passed the CARES Act. At the Fed, we used our powers to an unprecedented extent to stabilize the financial system and help stave off an economic depression.

After a historically deep but brief recession, in mid-2020 the economy began to grow again. As the risks of a severe, extended downturn receded, and as the economy reopened, we faced the risk of replaying the painfully slow recovery that followed the Global Financial Crisis.

Congress delivered substantial additional fiscal support in late 2020 and again in early 2021. Spending recovered strongly in the first half of 2021. The ongoing pandemic shaped the pattern of the recovery. Lingering concerns over COVID weighed on spending on in-person services. But pent-up demand, stimulative policies, pandemic changes in work and leisure practices, and the additional savings associated with constrained services spending all contributed to a historic surge in consumer spending on goods.

The pandemic also wreaked havoc on supply conditions. Eight million people left the workforce at its onset, and the size of the labor force was still 4 million below its pre-pandemic level in early 2021. The labor force would not return to its pre-pandemic trend until mid-2023. Supply chains were snarled by a combination of lost workers, disrupted international trade linkages, and tectonic shifts in the composition and level of demand. This was nothing like the slow recovery after the Global Financial Crisis.

Enter inflation

After running below target through 2020; inflation spiked in March and April 2021. The initial burst of inflation was concentrated rather than broad-based, with extremely large price increases for goods in short supply, such as motor vehicles. My colleagues and I judged at the outset that these pandemic-related factors would not be persistent and, thus, that the sudden rise in inflation was likely to pass through fairly quickly without the need for a monetary policy response—in short, that the inflation would be transitory. Standard thinking has long been that, as long as inflation expectations remain well anchored, it can be appropriate for central banks to look through a temporary rise in inflation.

The good ship Transitory was a crowded one, with most mainstream analysts and advanced-economy central bankers on board. The common expectation was that supply conditions would improve reasonably quickly, that the rapid recovery in demand would run its course, and that demand would rotate back from goods to services, bringing inflation down.

For a time, the data were consistent with the transitory hypothesis. Monthly readings for core inflation declined every month from April to September 2021, although progress came slower than expected. The case began to weaken around midyear, as was reflected in our communications. Beginning in October, the data turned hard against the transitory hypothesis. Inflation rose and broadened from goods into services. It became clear that the high inflation was not transitory, and that it would require a strong policy response if inflation expectations were to remain well anchored. We recognized that and pivoted beginning in November. Financial conditions began to tighten. After phasing out our asset purchases, we lifted off in March 2022.

By early 2022, headline inflation exceeded 6 percent, with core inflation above 5 percent. New supply shocks appeared. Russia's invasion of Ukraine led to a sharp increase in energy and commodity prices. The improvements in supply conditions and rotation in demand from goods to services were taking much longer than expected, in part due to further COVID waves in the U.S. And COVID continued to disrupt production globally, including through new and extended lockdowns in China.

High rates of inflation were a global phenomenon, reflecting common experiences: rapid increases in the demand for goods, strained supply chains, tight labor markets, and sharp hikes in commodity prices. The global nature of inflation was unlike any period since the 1970s. Back then, high inflation became entrenched—an outcome we were utterly committed to avoiding.

By mid-2022, the labor market was extremely tight, with employment increasing by over 6-1/2 million from the middle of 2021. This increase in labor demand was met, in part, by workers rejoining the labor force as health concerns began to fade. But labor supply remained constrained, and, in the summer of 2022, labor force participation remained well below pre-pandemic levels. There were nearly twice as many job openings as unemployed persons from March 2022 through the end of the year, signaling a severe labor shortage. Inflation (PCE) peaked at 7.1 percent in June 2022.

At this podium two years ago, I discussed the possibility that addressing inflation could bring some pain in the form of higher unemployment and slower growth. Some argued that getting inflation under control would require a recession and a lengthy period of high unemployment. I expressed our unconditional commitment to fully restoring price stability and to keeping at it until the job is done.

The FOMC did not flinch from carrying out our responsibilities, and our actions forcefully demonstrated our commitment to restoring price stability. We raised our policy rate by 425 basis points in 2022 and another 100 basis points in 2023. We have held our policy rate at its current restrictive level since July 2023.

The summer of 2022 proved to be the peak of inflation. The 4-1/2 percentage point decline in inflation from its peak two years ago has occurred in the context of low unemployment—a welcome and historically unusual result.

How did inflation fall without a sharp rise in unemployment above its estimated natural rate?

Pandemic-related distortions to supply and demand, as well as severe shocks to energy and commodity markets, were important drivers of high inflation, and their reversal has been a key part of the story of its decline. The unwinding of these factors took much longer than expected but ultimately played a large role in the subsequent disinflation.

Our restrictive monetary policy contributed to a moderation in aggregate demand, which combined with improvements in aggregate supply to reduce inflationary pressures while allowing growth to continue at a healthy pace. As labor demand also moderated, the historically high level of vacancies relative to unemployment has normalized primarily through a decline in vacancies, without sizable and disruptive layoffs, bringing the labor market to a state where it is no longer a source of inflationary pressures.

A word on the critical importance of inflation expectations:

Standard economic models have long reflected the view that inflation will return to its objective when product and labor markets are balanced—without the need for economic slack—so long as inflation expectations are anchored at our objective. That's what the models said, but the stability of longer-run inflation expectations since the 2000s had not been tested by a persistent burst of high inflation. It was far from assured that the inflation anchor would hold. Concerns over de-anchoring contributed to the view that disinflation would require slack in the economy and specifically in the labor market. An important takeaway from recent experience is that anchored inflation expectations, reinforced by vigorous central bank actions, can facilitate disinflation without the need for slack.

This narrative attributes much of the increase in inflation to an extraordinary collision between overheated and temporarily distorted demand and constrained supply. While researchers differ in their approaches and, to some extent, in their conclusions, a consensus seems to be emerging, which I see as attributing most of the rise in inflation to this collision. All told, the healing from pandemic distortions, our efforts to moderate aggregate demand, and the anchoring of expectations have worked together to put inflation on what increasingly appears to be a sustainable path to our 2 percent objective.

Disinflation while preserving labor market strength is only possible with anchored inflation expectations, which reflect the public's confidence that the central bank will bring about 2 percent inflation over time; That confidence has been built over decades and reinforced by our actions.

That is my assessment of events. Your mileage may vary.

Conclusion

Let me wrap up by emphasizing that the pandemic economy has proved to be unlike any other and that there remains much to be learned from this extraordinary period. Our Statement on Longer-Run Goals and Monetary Policy Strategy emphasizes our commitment to reviewing our principles and making appropriate adjustments through a thorough public review every five years. As we begin this process later this year, we will be open to criticism and new ideas, while preserving the strengths of our framework. The limits of our knowledge—so evident during the pandemic—demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges.”

Overall, on 23rd August (Jackson Hole), Fed Chair Powell emphasized on few points, which seems new to the market vis-à-vis Powell/Fed statement on 31st July (FOMC meeting), but in reality, he has not spoken about something, that the market does not know/already discounted to a great extent:

·         Powell/Fed has now growing confidence that inflation is sustainably moving towards +2% target; earlier he/Fed was also not fully confident; but still now, Powell didn’t say whether he is now fully (100%) confident or still partially (say 80%) confident

·         Fed/Powell Although some nervousness after the July job report published/accessed after the 31st July FOMC meeting, the Fed may not take any rate action decision based on a single month report; the Fed will consider at least Aug’24 report along with overall data in totality on 6M rolling basis

·         The US labor market conditions are now less tight than in Feb’20 (pre-COVID), when the headline unemployment rate was at 3.5% vs core PCE inflation +1.6%; against this, now July’24 unemployment rate was +4.3% vs core PCE inflation +2.7% (expected)

·         As the labor market is substantially cooled, the Fed thinks that it may not be one of the sources of further elevated inflationary pressure in the near term and thus Fed is not seeking further slack/cooling in the labor market conditions; i.e. Fed may not tolerate a further meaningful increase in the headline unemployment rate (say above 4.5% Fed red line)

·         As of now, overall data indicates the upside risk to inflation has diminished, while the downside risk to employment increased; thus to balance the dual mandate of maximum employment and price stability, the Fed will now do everything it can to support a strong labor market and make further progress toward price stability targets

·         Thus “the time has come for policy to adjust; the direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks”; i.e. officially Fed has now announced shift of policy stance from moderate/extreme restrictive to less restrictive in the coming days

·         Powell indicated a shift in focus from inflation control to concerns about the labor market; the Fed does not desire further weakening in employment conditions, implying that future monetary policy could become more sensitive to job/labor market data

·         Powell's pivot reflects a balancing act between maintaining economic growth and ensuring that inflation remains under control, progressing gradually towards the +2% target in a sustainable way for the medium-term

·         The rate cut question is now over; the question is now ‘when not what/if’

·         Looking ahead, the Fed will begin cutting rates gradually in an orderly way to reduce overall restrictive rates (real positive), the timing and pace of which will depend upon actual data, the evolving outlook and the balance of risks/dual mandate

·         Eventually, the Fed is trying to ensure inflation goes back to +2.0% in a sustainable way, keeping the labor market strong (soft landing)

·         As there is enough policy space (for cutting rates), it will be easy for the Fed to respond to any financial crisis in the coming days (like cutting rates to almost zero along with QE during COVID-2020; GFC-2007) to ensure financial, economic, employment and also price stability (to prevent deflation or too low inflation)

·         Fed may also respond even if there is a further slump in the labor market without a visible financial crisis (like the unemployment rate surged over 4.5% in August or September)

Overall, Powell sounded more dovish than expected on 23rd August at Jackson Hole than his earlier speech/comments on 31st July at FOMC presser. Dow Future, Gold jumped after Powell indicated an imminent rate cut to keep the labor market strong, while the progress of disinflation is in place. But Powell didn’t indicate rate cuts from Sep’24 are a done deal; he only confirmed the Fed’s change of stance from holding rates at restrictive levels to less restrictive levels by gradually cutting rates from the coming meeting in an orderly way. The market was expecting that Powell may indicate Sep’24 QTR specifically for launching the 11-QTR rate cut cycles.

But Powell only indicated data dependency for the Sep’24 rate cut and that too -25 bps, not -50 bps as some market implied probability indicates. But overall, after the July’24 terrible/mixed job report, Powell and other FOMC participants are now open for rate cuts from Sep’24 QTR if the Aug’24 US job report becomes too soft again and core inflation (disinflation) does not stall in August. Thus Dow Future, Gold also stumbled from the initial Powell put high and then recovered again to close near the day high.

In brief, on 23rd August (Jackson Hole), Powell didn’t say anything new, which the market does not know already. The market already discounted to a great extent that the Fed will start cutting rates from Sep’24 by cumulative 100/75 bps through Dec’24. Moreover, the Fed may cut the total -275 bps to +2.75% repo rate (from +5.50% at present) by Dec’26 or Dec’27.

On Friday, Fed’s Bostic said:

·         Patience is going to be warranted on the policy pathway

·         The jobs revision figures didn't change that much for me

·         We want a calm, orderly return to normalization

·         Inflation came down more than I expected

·         Inflation is not particularly close to the Fed target.

·         We still have a ways to go on inflation though, don't assume we are done.

·         Passive tightening via lower inflation is a thing

·         The labor market is a sign that we are getting back to a much more normalized place

·         We can't wait until inflation is back down to 2% to alter the policy rate

·         Our policy has had its effect and we can start the pathway back to normal policy posture

·         We are close to being ready to cut rates

·         We're going to have to think hard about what's happening in the labor markets

·         We want a calm, orderly return to normalization

On Friday, Fed’s Harker said (at Jackson Hole):

·         The neutral rate is somewhere around 3%

·         Contacts urging the Fed not to stop and start rate cuts

·         I don't see the large outsize risk of labor deterioration. In our view, the jobless rate will not peak above 5%

·         The Fed should start the process of cuts, and keep moving

·         We need to start moving rates down

·         We see softening in jobs from a very high level

·         I continue to worry about shelter inflation

·         I'm not in the camp of 25-bps or 50-bps cut, I need more data

·         We should start the process of rate cuts and keep it moving

·         My business contacts want a methodical course of rate cuts

·         The balance of risks is more normal, the Fed must watch jobs more now

·         The latest jobs report was a bit lower than expected, not a lot

·         The job market revisions weren't a surprise

·         The job market softening from a high level, heading back to normal

·         I am on board with the September cut if the data is as expected

·         A slow, methodical approach to cuts is the way to go

·         The job market has now mostly normalized

·         The end of the balance sheet drawdown (QT) is determined by the market; no major sources of financial stability worries

·         Markets have already moved to price in Fed action

·         Inflation is moving down, but it will take time to get to 2%

·         Fed rate cuts will likely ease housing sector pressure

·         Unemployment likely to rise to just below 5%

·         I continue to watch the commercial real estate sector

·         I am ready to start the process of cutting rates

·         I want a gradual, methodical course of rate cuts

·         Our current monetary policy is in a good place, not overly restrictive

·         The end of the easing cycle may put the funds rate around 3%

·         Business contacts favor a predictable pace of easing

On Thursday, Fed’s Collins said:

·         The labor market is healthy, I want to preserve it

·         The data give me more confidence on the path to 2% inflation

·         The economy is in a pretty good place, I do not see red flags

·         I have seen a significant reduction in inflation

·         Soon it will be appropriate to begin easing policy

·         Soon it is appropriate to begin cutting rates

·         Inflation and employment have come into better balance

·         We are not seeing red flags in consumption data

·         We still see quite a bit of continued resilience among consumers, as stress pockets though

·         A gradual, methodical pace of cuts, once we are in different policy stances, is likely to be appropriate

·         It is soon appropriate to begin cutting rates

·         Data on inflation are consistent with more confidence inflation getting back to 2%

·         The jobs market is healthy despite revisions

·         The Fed is in a healthy position overall and important to preserve that

·         Unemployment is still low and jobless claims indicate orderly rebalancing

·         Asked about job benchmark revisions: The data overall tells a consistent story

·         The labor market overall is quite healthy, and we want to preserve that

On Thursday, Kanas Fed’s President Schmid said:

·         There's room to reduce the balance sheet faster than we are now

·         Rates are not overly restrictive, we have time to decide

On Late Friday, Fed’s Goolsbee said (Jackson Hole):

·         The size of Fed cuts isn't important, it's the path

·         There's some question mark on the strength of the consumer

·         The neutral rates are far from where we are

·         The size of a given fed rate cut isn't what matters most, the path is key

·         I see warning signs, also signs of strength, in the economy

·         Fed forecasts have clearly shown the path of rate-cutting

·         The Fed needs to focus now on job mandate

·         We have gotten warning signs on the job market

·         I have every reason to think Fed forecasts of rate cuts will happen

·         Fed policy has been passively tightening as inflation cools

·         The funds rate was set at a time when inflation was much higher

·         We want to be careful about the employment side of the mandate

·         I don't think inflation will get stuck above 2%

·         By almost all measures, the job market is cooling

·         Everything we wanted to happen to get rates down, has happened

·         Policy is now at its tightest point of the entire hike cycle

·         Inflation is on a path to 2%

·         I support the Fed's new focus on the job markets

Most of the FOMC Policy makers except Goolsbee are in wait & watch mode to be more confident about launching the 11-QTR rate cut cycle from Dec’24 rather than Sep’24 and also not ready to accept the US labor/job market recession despite July’s terrible and 2024 negative revision for NFP.

Conclusions:

Overall, despite Powell put narrative at Jackson Hole's speech, Fed Chair Powell indicated Fed may further evaluate economic data in August (unemployment and core CPI) and the outlook thereof before deciding on the timing of rate cuts. If overall data is not satisfactory to provide the much-awaited full confidence about the disinflation process, then the Fed may further watch September data (Q3CY24) and outlook thereof for any rate cuts from Dec’24. If the Fed indeed goes for rate cuts based on one/two months of mixed/bad jobs data, then it may look Fed is panicking. In any case, the Fed may also start cutting rates from Sep’24, if Aug’24 job report shows higher unemployment (4.3%-4.5%) and satisfactory disinflation.

But, recent jobless claims and other data may also indicate better/improved/upbeat US job data for not only August but also for Sep and October and a moderate inflation report (ahead of Nov’24 US election) to justify Bidenomics. Fed is not in a hurry to start the rate cut cycles of 11 QTR cuts without evaluating data for a few more months in totality. Thus Fed may not only evaluate inflation and employment data for July and August but also for September and October/ November before launching the much-awaited rate cut cycles from Dec’24 QTR end.

Despite the market now suddenly panicking for a hard landing for the ‘terrible’ NFP/BLS job report for July, if we consider the increasing number of multiple job holders, higher number of temporary layoffs, and an unusual addition in labor force due to one-time seasonal factor), the overall nature of US labor market is still strong enough for Fed to continue its wait & watch stance to gain more disinflation pace and required full confidence to launch the series of rate cuts from Dec’24 rather than Sep’24. Fed is also of the view that the present weakness in the job market is not due to widespread layoffs due to any recession, but a cumulative effect of a higher number of workers/laborers and declining job openings from very high levels previously.

But even if the Fed responds to the present market panic and begins cutting rates from Sep’24 instead of Dec’24, it will make no significant difference in reality; even if the Fed cuts the rate by -25 bps each (no question of -50 bps pace), it will continue the pace of 4 rate cuts each in 2025-26 and one QTR/HLY cut in 2027. The market has already discounted about -275 bps rate cuts from Sep/Dec’24 till Dec’26/Dec’27.

The Fed may start the long-awaited eleven rate cut cycle from Dec’24 and may also indicate the same by Sep-Oct’24; the Fed will be in ‘wait & watch’ mode till at least Dec’24 as the Fed may want to observe inflation and employment data for Q3CY24. Also, the Fed may be on the sideline till the Nov’24 US election amid growing political & policy uncertainty after Biden exited from the Presidential run, paving the way for the Trump-Harris fight, which may not be smooth for Trump 2.0. Fed may not want to create any political controversy by opting for rate cuts just before the US Presidential election without the support of a terrible employment report. Trump has already warned Fed/Powell about rate cuts just before the election to help Biden/Harris (Democrats)!

Although the market is now almost discounting the start of Fed rate cuts from Sep’24, considering overall pace of disinflation, Fed may continue its wait & watch stance till at least Dec’24 and may continue to indicate that Fed is gaining incrementally higher confidence for overall disinflation process till Q2CY24, but still it’s not enough for launching the rate cut cycle in Sep’24 as Fed may want to be more confident after having actual data for another QTR. If Q3CY24 average US Core inflation (CPI+PCE) indeed goes around +2.9%; i.e. below the +3.0% ‘confidence’ line, then the Fed may officially indicate the start of the 11-QTR rate cut cycle from Dec’24 QTR till Dec’27 (two half yearly rate cuts in 2027).

The Fed will get the Sep’24 core inflation report by mid-late Oct’24 and accordingly may indicate the rate cut from Dec’24, just ahead of the Nov’24 election to keep both Democrats and Republicans happy; the Fed may indicate the start of a rate cut in Oct’24 (just ahead of the Nov’24 election) Fed talks and may start cutting rates from Dec’24 (just after the Nov’24 election), keeping Wall Street near life time high with some healthy corrections; both Democrats and Republicans will be happy too!

But at the same time Fed will continue its jawboning (forward guidance) to prepare the market to ensure the official dual mandate (maximum employment, price stability) along with an additional mandate to ensure financial and economic stability (Wall Street and bond market); Fed may not allow core real bond yield (10Y) above +1.0% under any circumstances to manage government borrowing costs, which is now hovering around 15% of US core tax revenue, quite elevated against EU and China’s 6% levels. At the same time, the Fed may not allow core 10Y bond real bond yield below average core CPI to continue its restrictive (real positive) policy stance at any cost to ensure durable price stability.

Bottom line:

At present, the 2024 (YTM) average of US core CPI is +3.6%, and the 6M rolling average is +3.5%, while the YTM and 6M rolling average of the unemployment rate is now 3.9% and 4.0%. Fed’s red line range of unemployment rate may be around 4.5-5.00%; i.e. Fed may not allow an unemployment rate above 4.5% on a sustainable basis for long.

Thus Fed may keep the 10Y US bond yield between 4.75/5.00% (upper range) and 3.50/3.25% (lower range) to ensure a proper balance for its entire mandate (maximum employment, price stability, and also financial stability). Looking ahead, the Fed may start cutting rates 11 times (QTR) @-25 bps from Dec’24, but the Fed is also open to cut rates from Sep’24 QTR if data supports (higher unemployment rate above 4.5%, while core CPI falls incrementally by another 0.1/0.2%). Fed will not go for -50 bps rate cuts at one go at this point.

Although the Fed is nervous/worried to some extent after the unemployment rate surged to 4.3% in July unexpectedly, it may be also a case of transitory factors and the headline unemployment rate may also soon fall below 4.0% in the coming months. Thus Fed may not decide about the Sep’24 rate cut or hold without evaluating the Aug’24 job and core inflation data in totality. Thus despite growing probability, the Sep’24 rate cut is not a done deal.

Likely Market impact of Fed rate cuts:

The Market is already discounted almost fully about the Fed’s upcoming rate cut cycle of 11 cuts, cumulating -275 bps over the next two/three years (Dec’26-Dec’27). This coupled with Trump 2.0 optimism (tax cuts, deregulation and large infra stimulus), the SPX-500 is again approaching life time high/likely fresh LTH region around 5750-5850 zones against TTM EPS $191.39. In that scenario, the TTM PE would be over 30; i.e. in the extreme bubble zone against the normal PE range 15 (bear market), 20 (neutral/fair value) and 25 (bullish market) and average EPS growth rate around 12.5%.

Thus at present, SPX-500 may be hovering around the bubble zone and even if the Fed cuts rates in Sep’24, SPX 500 (CMP: 5650) may not sustain above 5750-5850 zones and may also stumble from there, whatever may be the reasons; it may be Gaza/Ukraine war miscalculation, end of JP/Yen carry trade and even US/China slowdown with real estate/CRE crisis. Also, US election uncertainty/outcome and subsequent hung Congress/Parliament/Political & policy paralysis may cause another market meltdown. Historically, most of the time, Fed rate cuts coincided with some form of global financial crisis like the Great Recession –GFC (2007-2009); the 1998 Global Currency Crisis: the Dot-Com Bubble Burst (2000-2001) and lastly late 2019 Repo tantrum and 2020 COVID-19.

At around 5650 CMP and TTM EPS $191.39, the current TTM PE of the S&P 500 is now around 29.50; i.e. almost at 30.0 extreme bubble zone and significantly above 20 fair/neutral PE or even 25 bullish PE levels. Thus looking forward, even if SPX-500 further surges to the 5750-5850 zone (2-4%) due to an early/delayed Fed pivot, likely Gaza war ceasefire and even Trump 2.0 optimism, SPX-500 may correct soon from that zone (5750-5850).

Market wrap:

On Friday, Wall Street Futures and Gold surged on Powell put after a roller coaster move; Dow Future initially surged to around 41300 from 41000 as Powell indicated an imminent rate cut to keep the labor market strong, while the progress of disinflation in place. But Powell didn’t indicate rate cuts from Sep’24 are a done deal; he only confirmed the Fed’s change of stance from holding rates at restrictive levels to less restrictive levels by gradually cutting rates from the coming meeting in an orderly way. The market was expecting that Powell may indicate Sep’24 QTR specifically for launching the 11-QTR rate cut cycles.

But Powell only indicated data dependency for Sep’24 or future rate cut and that too -25 bps, not -50 bps as some implied market probability indicates. But overall, after the July’24 terrible/mixed job report, Powell and other FOMC participants are now open for rate cuts from Sep’24 QTR if the Aug’24 US job report becomes too soft again and core inflation (disinflation) does not stall in August.

Thus Dow Future stumbled from initial Powell put high around 41300 to almost 40900 and then recovered again to close near the day high 41268. Similarly Gold initially surged from around 2495 to almost 2518 and then stumbled to almost 2500 and then recovered to close around 2512. Gold was also undercut by the progress of Gaza war ceasefire negotiations and as Iran said they have no imminent plan of Israel retaliation; but Hezbollah may act as a proxy for Iran.

On Friday, blue-chips DJ-30 surged +1.14% (+462 points), tech-savvy NQ-100 jumped +1.18%, while broader SPX-500 gained +1.15% on hopes & hypes of an early Fed pivot. On Friday, Wall Street was boosted by almost all the major sectors led by interest-sensitive real estate, consumer discretionary, techs, energy, materials, industrials, banks & financials, healthcare, communication services, utilities and consumer staples. Scrip-wise, Wall Street was boosted by Home Depot, Goldman Sachs, Intel, Salesforce, Dow Inc., Travelers, Caterpillar, 3M, American Express, Amgen, Chevron, Boeing, Honeywell, J&J, Cisco, Apple, Nvidia, Tesla and United Health, while dragged by P&G and Visa.

Weekly-Technical trading levels: DJ-30, NQ-100, SPX-500, and Gold

Whatever the narrative, technically Dow Future (41260) has to sustain over 41500 for any further rally to 41650/41750*-41950/42100* and 42700/41900-43050/44250-44500/44800 in the coming days; otherwise sustaining below 41450, DJ-30 may again fall to 41000/40700-40500*/40300 and 40150/40000*-39700/39450 and further 39350/39200-39100/38900 and 38500*/38300-38000/37600 in the coming days.

Similarly, NQ-100 Future (19790) has to sustain over 20100-20200 for any further rally to 20300*/20600-20800/21050* and further to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 20050. NQ-100 may again fall to 19750/19650*-19550/19400 and 19300/19100-18800/18700* and further 18550/18450-18200/17950 and may further fall to 17650/17450-17300/17000 in the coming days.

Technically, SPX-500 (5650), now has to sustain over 5700 for any further rally to 5725/5750*-5850*/5900 and 6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5650 may again fall to 5575/5550-5450/5400* and 5440/5300-5250/5100* and further 5050/4950*-4850/4750 and 4550/4450-4350*/3850 in the coming days.

Also, technically Gold (XAU/USD: 2510) has to sustain over 2540 for a further rally to 2560*/2575-2600/2650 in the coming days; otherwise sustaining below 2535-2520, may fall to 2490/2480-2460/2445* and 2435/2420-2410/2400 and further to 2375/2350*-2325/2300 in the coming days.