Dow edged down on hotter inflation expectations; Gold slumped

·         Fed may not cut rates from Sep’24, just ahead of the US election in Nov’24 to avoid any political controversy; Fed may cut rates from Mar’25 every QTR

On Friday, Wall Street Futures, US bonds, and USD stumbled on increasing concern about stagflation amid higher US/UM inflation expectations and lower consumer sentiment. But Gold surged as it may be a major beneficiary of stagflation; also various central banks led by PBOC/China may be actively buying Gold at every major dip to gradually diversify from USD and also to strengthen LCU (local currency unit). Gold was also boosted by lingering suspense about the Gaza war ceasefire and a fresh offensive by IDF/Israel at Rafah to pressure Hamas either to accept the current cease-fire proposal on the plate or face another all-out war in Rafah crossings. Gold reached a high of almost 2378, before closing around 2360. Wall Street Futures also stumbled from earlier day high on hopes & hypes of an early Fed pivot and mixed report card.

On Monday, some focus of the market was also on US inflation expectations data (NY Fed survey) after Friday’s elevated data by the UM, at a 6-month high. The NY Fed data shows U.S. consumer inflation (CPI) expectations for the year ahead (1Y) increased to +3.3% in April, the highest since Nov’23, from +3% in each of the previous four months.

One-year-ahead inflation expectations rose across the board, namely for gas, food, medical care, college education and rent. Also, median home price growth expectations increased to 3.3%, the highest since July 2022, after remaining unchanged at 3% for seven consecutive months. Meanwhile, inflation expectations at the three-year horizon decreased to 2.8% from 2.9% but increased to 2.8% from 2.6% at the five-year horizon. In addition, median one-year-ahead expected earnings growth decreased by 0.1 percentage point to 2.7% and unemployment expectations increased by 1 percentage point to 37.2%

Full report summary by the BY Fed:

The Federal Reserve Bank of New York’s Center for Microeconomic Data today released the April 2024 Survey of Consumer Expectations, which shows that inflation expectations increased at the short-term and longer-term horizons while decreasing at the medium-term horizon. Home price growth expectations reached the highest level since July 2022. Spending growth expectations also increased. The average perceived likelihood of voluntary and involuntary job separation declined, as did the perceived likelihood of finding a job in the event of a job loss.

The main findings from the April 2024 Survey are:

Inflation

Median inflation expectations increased to 3.3% from 3.0% at the one-year horizon (remaining below its 12-month trailing average of 3.5%), decreased to 2.8% from 2.9% at the three-year horizon, and increased to 2.8% from 2.6% at the five-year horizon. The survey’s measure of disagreement across respondents (the difference between the 75th and 25th percentile of inflation expectations) decreased at the one-year horizon and increased at the three-year and five-year horizons.

Median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—increased at the one- and five-year horizons and declined at the three-year horizon.

Median home price growth expectations increased to 3.3% after remaining unchanged at 3.0% for seven consecutive months. This is the highest reading of the series since July 2022. The increase was most pronounced for respondents with a high school degree or less.

Year-ahead commodity price expectations rose across the board in April, increasing by 0.3 percentage points for gas to 4.8%, 0.2 percent point for food to 5.3%, 0.6 percent point for the cost of medical care to 8.7%, 2.5 percentage points for the cost of college education to 9.0% and 0.4 percentage point for rent to 9.1%.

Labor Market

Median one-year-ahead expected earnings growth was decreased by 0.1 percentage point to 2.7%. The decline was driven by respondents with a high school degree or less. While lower, the current reading remains well above the 2.0%-2.2% levels prevailing at the onset of the pandemic.

Mean unemployment expectations—or the mean probability that the U.S. unemployment rate will be higher one year from now—increased by 1 percentage point to 37.2%, remaining below its 12-month trailing average of 38.2%.

The mean perceived probability of losing one’s job in the next 12 months decreased by 0.6 percentage points to 15.1%. The mean probability of leaving one’s job voluntarily in the next 12 months also declined, by 1.2 percentage points to 19.4%.

The mean perceived probability of finding a job if one’s current job was lost declined for the fourth consecutive month, to 50.9% from 51.2% in March. This is the lowest reading of the series since April 2021.

Household Finance

Median expected growth in household income declined by 0.1 percentage point to 3.0%. The series has been moving within a narrow range of 2.9% to 3.3% since January 2023 and remains above the February 2020 pre-pandemic level of 2.7%.

Median household spending growth expectations were increased by 0.2 percentage points to 5.2%. The increase was most pronounced for respondents with some college education.

Perceptions of credit access compared to a year ago improved with a smaller share of respondents reporting tighter conditions compared to a year ago. Expectations about credit access a year from now also improved with a smaller share of respondents expecting tighter credit a year from now.

The average perceived probability of missing a minimum debt payment over the next three months remained unchanged at 12.9%. The series remains above its 12-month trailing average of 11.8%.

The median expected year-ahead change in taxes at the current income level increased by 0.1 percentage point to 4.3%.

Median year-ahead expected growth in government debt remained unchanged at 9.6%.

The mean perceived probability that the average interest rate on saving accounts will be higher 12 months from now increased by 1.3 percentage points to 25.5%, remaining below its 12-month trailing average of 28.8%.

Perceptions about households’ current financial situations deteriorated with fewer respondents reporting being better off and more respondents reporting being worse off than a year ago. Year-ahead expectations also deteriorated marginally with a smaller share of respondents expecting to be better off a year from now.

The mean perceived probability that U.S. stock prices will be higher 12 months from now decreased by 0.5 percentage points to 38.7%.

Overall, the latest NY Fed survey data about US consumer expectations indicate US common public is less confident about the future amid elevated cost of living, minuscule real wage growth and an increasingly Colling job market. The NY Fed report is similar to the UM survey, indicating a majority of US common people (voters) are not happy about Bidenomics and may shift towards Trumponomics in the Nov’24 election.

Although the overall economic situation is in line with the Fed’s effort to produce more slack in the economy through a higher longer (restrictive) rate policy, the Fed may avoid rate cuts from Sep’24, just ahead of the Nov’24 election to avoid any political controversy. If Trump becomes the next US President, taking White House charge from Jan’25, then he may soon demand Fed rate cuts and close of QT like we have seen in his 1st term during 2016-20 (Trump tantrum). Thus Fed/Powell may start cutting rates from Mar’25 at -25 bps each quarter till 2026. Presently, the market is expecting at least -50 bps rate cuts in 2024, starting from Sep’24 ahead of April core CPI data to be released on 15th May.

On Monday, the US Treasury Secretary Yellen said:

·         Biden's top priority is bringing down inflation

·         It is unacceptable to be dependent on China in key industries

·         We do not wish to disengage economically with China.

·         Any steps on China should be targeted, and not broad-based

·         Tax revenues should be used to lower the deficit

·         If FX intervention happens, it should be for excess moves

·         Interventions should be rare and communicated to others

·         We value our trade and investment relationship with China but have areas where we have disagreements with China

·         We will ensure counterparts are informed--(When asked if she will inform China ahead of any US tariff action)

·         We've been clear that we may reconfigure tariffs imposed under Trump in a "more strategic way"

On Monday, Fed’s VC Jefferson said:

·         Sometimes Fed communications can be misinterpreted

·         Clear communications are important for central banking

·         Sometimes active Fed speaking can create, and not reduce uncertainty

·         There is always a risk that Fed comments on the outlook are viewed as a fixed projection

·         There's a risk of confusion when officials speak but disagree

·         Clear communication contributes to effective policy

·         The economy has made a lot of progress, but inflation has retreated

·         The labor market has been very resilient

·         Inflation has come down substantially from its peaks

·         I view the economy as in a solid position

·         The decline in inflation has attenuated

·         It is appropriate that we maintain the policy rate in restrictive territory

·         Inflation is a source of concern

·         It's important to look for more evidence that inflation is abating

·         It is appropriate to keep the policy rate restrictive until clear inflation is ebbing

·         The economy has made a lot of progress, inflation has retreated

·         The dot plot is useful if it is properly interpreted

On late Friday, Fed’s Barkin said:

·         Demand is solid, and not overheating

·         I am looking for inflation progress to sustain and broaden

·         The current economy calls for a deliberate and patient approach

·         With appropriate policy and time, inflation will hit 2%

Conclusions:

Overall, the Fed is now changing its tone and gradually preparing the market for no rate cuts in 2024, especially from Sep’24 to avoid any political controversy just ahead of Nov’24 US election.

The 6M rolling average of the US unemployment rate is now around +3.8%, while core CPI inflation is around +3.9%; i.e. US core CPI inflation is still substantially above the Fed’s +2.0% targets, while unemployment rate is still below the Fed’s 4.0% red line. Thus theoretically, the Fed has still space for a higher longer policy stance (restrictive) to produce additional slack in the economy, so that underlying demand decreases further to some extent to match the present supply capacity of the economy, bringing inflation down towards +2.0% targets on a sustainable basis. Fed now needs more confidence for the disinflation process, which is now almost stalled after a good pace in H2CY23.

Also, looking ahead, the Fed may keep B/S size around $6.60-6.50T, around pre-COVID levels and 22% of estimated CY26 nominal GDP around $30T to ensure financial/Wall Street stability along with Main Street stability; i.e. price and employment stability. Fed’s B/S size should be around $7.30T by May’24. At around the projected QT tapering rate of $0.04T/M, it may take 18 months from June’24 to reach the targeted Fed B/S size of around $6.60T; i.e. by Dec’25, Fed’s QT may end with the B/S size around $6.60-6.50T.

Rate cuts along with QT (even with a slower pace/tapering) should be less hawkish:

Ahead of the Nov’23 U.S. Presidential election, White House/Biden/Fed/Powell is more concerned about elevated inflation rather than the labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some anti-incumbency wave (dissatisfaction) among the general public (voters) against Biden admin (Democrats) amid higher cost of living.

Thus Fed is now giving more priority to price stability than employment (which is still hovering below the 4% red line) and is not ready to cut rates early as it may again cause higher inflation just ahead of the November election. Fed may have cut only from Septenber’24, which will ensure no inflation spike just ahead of the Nov’24 election (as any rate action usually takes 6-12 months to transmit in the real economy, while boosting up both Wall Street and also Main Street (investors/traders/voters). Fed hiked rate last on 26th July’23 and may continue to be on hold till at least July’24; i.e. around 12 months for full/proper transmission of its +5.25% cumulative rate hikes effect into the real economy.

Overall, the Fed’s mandate is to ensure price stability (2% core inflation), and maximum employment (below 4% unemployment rate) along with financial/Wall Street stability as well as lower borrowing costs for the government. As the US is now paying almost 15% of its tax revenue as interest on debt, the Fed will now not allow the 10Y US bond yield above 5.00% at any cost (against present levels of average core CPI around +4.0%).

But the Fed may also blink on rate cuts in H2CY24 just before the US election to avoid any political controversy:

Ahead of Nov’24 US Presidential election, as seen in the Mar’24 Congressional testimony, Fed/Powell is under huge pressure from opposition Republican lawmakers (Trump & Co) to support Biden & Co (Democrats) in boosting the election prospect by facilitating rate cuts just before the Nov’24 election. Thus Fed may not go for any rate cuts till Nov’24 or even Dec’24 to show that it’s politically independent/neutral.

The most logical step would be Fed to close the QT completely before going for a rate cuts cycle and then go for any QE, if required to counter another economic crisis down the years. Fed has to prepare its B/S for the next round of QQE to face another cycle of financial crisis and thus has to normalize the B/S first. Presently, it seems that the Fed is not so confident about the original QT pace, around 0.07T/M which may trigger another QT tantrum, as we have seen in late 2019.

Fed is ‘extremely’ worried about the pace of slower disinflation. Fed is also apparently confused about the dual combination of QT, even at a slower pace (QT taper) and rate cuts in the months ahead as these two instruments (tools) are contradictory/opposite (like if the Fed goes for QE and rate hikes at the same time). Ideally, the Fed should finish the QT first for a proper B/S size (bank reserve) to ensure ample liquidity for the US funding/money/REPO market.

But the Fed may continue QT (even at a slower pace) and go for a rate cut cycle at the same time despite these two policy actions being contradictory. Bank of Canada (BOC), recently clarified as long as the policy rate remains within the sufficiently restrictive zone, BOC may go for limited rate cuts, along with QT (even at a reduced pace) as QT is itself equivalent to rate hikes to some extent (tighter banking/funding/money market liquidity). If the real policy rate falls into the stimulative zone amid a fall in inflation, then the BOC may go for more rate cuts and completely close or at least temporarily close the QT. BOC is the smaller proxy of the Fed and may have more academic clarity regarding its policy actions.

Thus the Fed may go for rate cuts of -75 bps cumulatively in September, November, and December’24 for +4.75% repo rates from the present +5.50%. But after recent remarks by various Fed policymakers, it seems that the Fed may not cut thrice in 2024 from Sep’24 and may cut only once (symbolic) in Dec’24 or may not cut at all in 2024.

The market is now expecting 3 to 1 rate cuts (75-50 bps) in 2024, while some Fed policymakers are now arguing for lesser rate cuts of 1-2 rate cuts or even no rate cuts at all. Looking ahead, the Fed may not cut rates at all in 2024 considering the slower rate of disinflation, political issues ahead of the Nov’24 election, and the logic that it should not go for any rate cuts while doing QT, which is the opposite. Also, the reduction of B/S from around $8.97T to around $6.60T (projected); i.e. around $2.50T (~$2.37T) reduction over 2.5-3.00 years is equivalent to a rate hike of around +50 bps (higher 2Y bond yield).

In that scenario, if the US core CPI average for 2024 comes down to around +3.00% by Dec’24 from present levels of +3.8%, the Fed may cut rates by -100 bps in 2025 for a repo rate +4.50% (from present +5.50%) for a real restrictive repo rate +1.50% (repo rate 4.50%-3.00% projected average core spi for 2024). Presently, the real restrictive repo rate is also around +2.00% (repo rate 5.50%-3.50% average 6M core inflation).

At present, in its last (Mar’24) SEP/dot-plots, the Fed projected -75 bps rate cuts each in 2024, 2025, and 2026 and -50 bps rate cuts in 2027 for a terminal neutral repo rate +2.75% against pre-COVID neutral repo rate +2.50%. Now various Fed policymakers are arguing for a slightly higher neutral repo rate at +3.00% against projected core CPI of +2.00%; i.e. neutral real rate at +1.00%.

Thus depending upon the actual trajectory of core CPI, the Fed may cut -100 bps each in 2025, 2026, and -50 bps in 2027 for a terminal neutral repo rate of +3.00% from the present +5.50%. Fed had boosted its B/S from around $3.86T in late September’2019 (after the QT tantrum) to around $8.97T in Apr’22; i.e. over $5T in a matter of 32 months (@0.16T/M) to fight previous QT and COVID induced financial crisis.

Although, the Fed’s official QT rate is -$0.095T/M ($90B/M), in reality, the effective average QT rate is already around -$0.073T/M. As the Fed is now managing the funding/money market through ON/RRP, there is a lower risk of a 2019 type of QT tantrum this time.

Fed’s mandate is now 2% price stability (core inflation), below 4% unemployment rate, and below 4.75-5.00% US 10Y bond yield to ensure lower borrowing costs for the government and overall financial stability. Fed, as well as ECB, BOE, and BOC, are now struggling to keep bond yield and inflation at their preferred range despite non-stop jawboning; perhaps they are talking too much too early and thus FX market is not being influenced by them significantly, moving in a narrow range. The BOJ is now trying to talk down the USDJPY desperately, presently hovering around 152 levels, causing higher imported inflation and a higher cost of living back home, although it may be beneficial for exports. However, most of the Japanese are not happy at all due to higher imported inflation in Japan for the devalued currency.

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.5%. Fed may cut 75 bps in H2CY24 if the 6M rolling average of core inflation (PCE+CPI) indeed eased further to +3.0% by H1CY24. The Fed wants to keep the real/neutral rate around +1.0% in the longer term (assuming a +3.0% repo rate and +2.0% core inflation). But in the meantime, till core inflation/headline inflation goes down to around 2.00%  on a sustainable basis, the Fed wants to maintain the real rate at around present restrictive levels of 1.00-2.00% (assuming the present repo rate 5.50% and 2023 average core inflation around 4.50% and present 6M rolling average of core inflation around 3.50%). Fed needs a +2.00% restrictive real rate for 2024 or at least H1CY24 to produce sufficient slack in the economy, so that core inflation falls to +2.0% target on a sustainable basis.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C-D)*(E-B)

=1.50+2.00+ (2.60-2.00)*(4.50.00-2.00) =1.00+2+ (0.60*2.50) = 3.00+1.50=4.50% (By Dec’24)

Here:

A=desired real interest rate=1.50; B= inflation target =2.00; C= Actual real GDP growth rate for CY23=2.6; D= Real GDP growth rate target/potential=2.00; E= average core (CPI+PCE) inflation for CY23=4.50%

Less likely: 1st scenario: 75 bps rate cuts each in 2024, 2025, 2026, and -50 bps in 2027 for a neutral repo rate of +2.75%; More likely 2nd scenario: -100 bps rate cuts each in 2025, 2026, and -50 bps in 2027 for terminal neutral reo rate +3.00%

Fed will continue the QT at a reduced rate of around 40B/M till Dec’25 for a B/S size of around $6.60-6.50T. Fed may continue the QT (even at an officially slower pace) and rate cuts at the same time despite being contradictory. Fed may say (like BOC) that as long as the policy rate is in the restrictive zone (say 1.50-2.00% above core inflation), the Fed may continue both rate cuts and QT to reduce overall restrictiveness. When the policy rate moves into a neutral/stimulative zone, say 50 bps above average core inflation, then the Fed may go for more rate cuts and close the QT.

All other major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may be compelled to follow the Fed’s real rate action to keep present policy differential with the Fed. As USD, is the primary global reserve/trade currency, any meaningful negative divergence with the Fed will result in higher imported inflation, everything being equal; for example, if the ECB goes for -75 bps rate cuts in H2CY24, while the Fed goes for hold, then EURUSD may slip further towards parity (1.0000), which will result in higher imported inflation as the EU is dependent quite heavily on imported goods, foods, and fuel/commodities.

In this way, no major G20 Central Bank will take such rate action/cuts alone as there is a routine/regular coordination/consultation between all major central banks for a coordinated/synchronized policy action to avoid disorderly FX movement. The Fed also not seeking a very strong USD as it would eventually affect US export competitiveness. Thus all major central banks are now focusing on maintaining proper balance and coordination with the Fed, whatever may be the domestic inflation/economic narrative/jawboning.

Market impact:

On Monday, Wall Street Futures and gold inched down on fading hopes of an early Fed pivot amid hawkish Fed jawboning, hotter inflation expectations and softer consumer confidence. Earlier lower USD/US bond yields helped Wall Street and gold to some extent as JPY surged on reports of less JBB bond buying by BOJ. But Wall Street sentiment was also affected by subdued Chinese economic data and China’s fiscal stimulus plan. Blue Chip DJ-30 snapped an 8-day winning streak, losing around -81 points (-0.32%), broad-based SPX-500 edged down -0.16%, while tech-savvy NQ-100 edged up +0.3%.

On Monday Wall Street was boosted by techs and real estate only, while dragged by industrials, banks ^ financials, consumer staples, energy, consumer discretionary, communication services, healthcare, materials and utilities to some extent. Scrip-wise Wall Street was boosted by Intel, Nike, Apple, Cisco, J&J, 3M, Caterpillar, and Coca-Cola, while dragged by Home Depot, American Express, McDonald’s, Travelers, Amgen, Amazon, Microsoft, Nvidia and Alphabet. Apple surged after a report that it is nearing a deal to put OpenAI technology on the iPhone, while rival Google parent Alphabet tumbled on the JV report. Chinese regulators tell tech firms in China to buy fewer Nvidia chips.

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

Whatever may be the narrative, technically Dow Future (39545) has to sustain over 39800 for a further rally to 40000/40350-40450/40600 and even 40700-42600 levels in the coming days; otherwise, sustaining below 39750, DJ-30 may again fall to 39500/39200-39000/38800 and further to 38600/400-38100/37950-37650/37450*, and further fall to 37300*/37200-37050/36600 and 36300/36300 and even 35700 levels in the coming days.

Similarly, NQ-100 Future (18280) has to sustain over 18400 for any recovery/rally to 18600/18750-18800/18900*-19100/19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18350-18250 may again fall to 18100/18000 and 17800/17700-17600-17500 and 17400/17300-17100/17000* and 16890/16700-16595*-16100/15900 in the coming days.

Also, technically Gold (XAU/USD: 2359) has to sustain over 2385-90/97 for a further rally to 2400/2410-2425/2435* to 2455-2475/2500; otherwise sustaining below 2380-2370, may again fall to 2355/2345-2335/2325 and further to 2315/2300-2290/2270* and 2255/2235*, and 2180/2145*, and further to 2120*/2110-2100/2080-2060/2039 and 2020/2010-2015 in the coming days.