Dow, Gold, and USD wobbled on sequentially softer US core CPI

·         The disinflation trajectory still fails to provide the Fed the necessary confidence for any cut; the PPI report already indicated a 0.3% sequential rate of CPI

On Tuesday, Wall Street Futures and gold surged after knee-jerk low even after hotter than expected US PPI report as negative revisions and the overall mixed nature of the report indicated a +0.3% sequential US core CPI pace in April rather than +0.4% market expectations. The odds for a Fed rate cut initially fell but then returned to the same level as they were before the PPI release, at 65% in September and 78% for November.

On Wednesday, all focus of the market was on U.S. core CPI inflation for April as it may influence the Fed for any rate action/policy stance change in June. Although the market is already discounting a pause for the June meeting, the Fed will still evaluate core CPI data for April’24 along with the 2023 average and 6M rolling average for change of any policy stance required in H2CY24. The market is now still broadly discounting -75 bps rate cuts in late 2024 (September/November/December).

On Wednesday, the BLS data (NSA) shows the annual (y/y) US core CPI inflation edged down to +3.6% in Apr’24 from +3.8% sequentially, in line with the market consensus of +3.6% and at the lowest in 3-years (since Apr’21).

In Apr’24, the annual US core CPI was continuously boosted by the heavy-weight shelter index, which increased by +5.5%, but also eased from the Mar’24 rate of +5.7%; other indexes with notable annual increases are motor vehicle insurance, medical care, personal care, and recreation.

The U.S. Core service inflation (w/o energy service) also eased to +5.3% in Apr’24 from +5.4% sequentially and Jan’23 reading of +7.2%, but it’s still substantially above pre-COVID average levels of 2.8%. Fed is now closely focusing on core service inflation, which is still quite elevated and sticky.

Also, the US super core CPI (less volatile food, fuel/energy, shelter, and used cars & trucks) was unchanged at +2.6% in Apr’24 against pre-COVID average levels of around +1.5%

On Wednesday, the BLS data (SA) showed the sequential (m/m) US core CPI raised +0.3% in Apr’24, eased from +0.4% in Mar’24, and below market expectations of +0.4% advance (the sharpest increase in sequential core CPI inflation since Apr’23.) In Apr’24, the sequential core CPI was boosted by transportation services, and shelter while dragged by new vehicles, and used cars & trucks. Although the market consensus of sequential core CPI was already changed from +0.4% to +0.3% after core PPI data Tuesday, Wall Street Futures, Gold surged after sequential core CPI indeed came around +0.3% in Apr’24 and not at +0.4% earlier expected. The Fed needs a +0.2% (~0.15%) average sequential core CPI rate on a sustainable basis for its +2% annual core inflation target on a sustainable basis.

Overall, the average of US core CPI remained unchanged around +3.8% in 2024 (YTD) against +4.8% in 2023 against +6.2% in 2022, while the 6M rolling average is now around +3.8% (y/y), eased from the prior +4.0%. The annualized rate of 6M rolling average of sequential (m/m) core CPI is now around +4.0%, still substantially above the Fed’s +2.0% targets.

In brief, core CPI although cooled almost -100 bps from 2023 average levels, the disinflation pace has been stalled in Q1CY24, keeping the Fed opting for higher for longer policy. Fed required more pace of disinflation for its confidence to cut rates in the coming days. Also, the core PPI sequential rate for Apr’24 at +0.5% (flash data) may indicate the higher sequential rate of core CPI in May/June if the Apr’24 PPI data is not revised drastically downwards.

As per core CPI/PPI data trend, the US core PCE inflation may also increase by around +0.3% in Apr’24, resulting in an annual rate of around +2.8% and a 6M rolling average of around +2.9%. In that scenario, the 6M rolling average of US core inflation (PCE+CPI) will be now around +3.4% in April, eased from earlier +3.5% in March.

On Wednesday, the BLS data (NSA) shows the annual (y/y) US CPI inflation edged down to +3.4% in Apr’24 from +3.5% sequentially, in line with the median forecasts of +3.4%, just below the highest (in Mar’24) since Sep’23. In Apr’24, the US CPI was boosted by food, energy, transportation services, apparel, and shelter, while dragged by new vehicles, used cars & trucks.

 

On Wednesday, the BLS data (SA) shows the sequential (m/m) US CPI raised +0.3% in Apr’24, eased from +0.4% in Mar’24 and below market expectations of +0.4% advance. In Apr’24, the sequential core CPI was boosted by shelter. Energy, MV insurance, apparel, and medicare while dragged by new vehicles, used cars & trucks, household furnishings & operations.

But the market consensus of sequential core CPI was also eased from +0.4% to +0.3% after PPI data Tuesday. Overall on Wednesday, the ‘unexpected’ decline in sequential CPI/core CPI was largely in the ‘expected’ line after Tuesday's PPI report showed a huge negative revision of sequential PPI in March. But at the same time, Apr’24 sequential PPI also jumped +0.5%, which may keep May sequential CPI/core CPI elevated around 0.4-0.5% if again not negatively revised.

Overall, the 6M rolling average of CPI inflation is now around +3.3% in Apr’24, while the 6M rolling average (+0.3%) of annualized sequential CPI is now around +3.7%-still significantly higher than Fed’s target of +2.0% on a sustainable basis. Officially, the US Congress has given the Fed a target of headline CPI, not PCE inflation or even core CPI. But the Fed usually targets the average of core PCE and core CPI, which may come around +3.4% in Apr’24, almost equivalent to the headline CPI average.

Overall, the US core disinflation has been stalled in Q1CY24, which may keep the Fed on hold till at least Q2CY24; the Fed will not react too much for April data and may watch at least another QTR; i.e. Q2CY24 for any rate cut confidence. On 31st July (Fed meet day), the Fed will have full inflation and employment data for Q2CY24 or H1CY24. Accordingly, if average core inflation indeed dips below +3.0%, the Fed may go for any rate cuts from Sep’24 for -75 bps or even -50 bps rate cuts in Dec’24 to avoid any political controversy by going for rate cuts just before the US Presidential election in Nov’24.

On Wednesday gold, Fed’s Kashkari said:

·         The Fed is focused on lowering underlying demand in the economy to get inflation down

·         Americans have been spending more than I would have expected

·         The housing market has been more resilient than I expected, it's an area I'm very focused on

·         The big question mark now is, how restrictive is policy right now?

·         We probably need to sit here for a while longer to figure out where inflation is headed

·         With higher US government debt, it might take higher borrowing costs in the nearer term to achieve 2% inflation

·         Fed is focused on underlying demand to bring inflation down

·         Bitcoin has little practical use, it's not an investment vehicle or a currency

On Wednesday, Chicago Fed’s President Goolsbee said:

·         If the housing inflation decrease seen in April CPI continues, that's great!

·         Goolsbee is optimistic inflation will continue to decline

·         Good Inflation Data Needed for Months to be Pleased

On Wednesday, Fed’s Mester said:

·         Not eager to consider interest rate hikes

·         Fed in ‘really good place’ to study economy before charting rate path

On Wednesday, the U.S. Treasury Secretary Yellen said:

·         New Chinese tariffs won't result in significant price increases in the US

·         Hopes China Reacts to New Tariffs in Rational Way

·         Expects American-Made EV Prices to Decrease Over Time

·         New tariffs on China won't result in significant price rises in the US

On Wednesday, the US President Biden said:

·         April CPI shows prices are still too high

On Wednesday, the influential Fed watcher Timiraos (WSJ) said:

·         One good print can't offset three unfavorable ones

On early Thursday, the NY Fed President Williams said:

·         I still lack confidence in inflation moving sustainably to 2%

·         Optimistic inflation will continue to retreat & the overall trend for slowing inflation looks good

·         April CPI was a positive development for inflation dynamics

·         Optimistic inflation will continue to retreat & the overall trend for slowing inflation looks good

·         April CPI was a positive development for inflation dynamics

·         We need not wait until inflation is exactly at 2% to ease policy

·         I see inflation in the low 2% range by the year's end and around 2% next year & expect unemployment to rise to 4% this year

·         I hope the job market can balance without a big rise in unemployment. The job market is still tight, but excesses are waning

·         The economy is moving into a better balance

·         I don't see any current need to raise interest rates

·         The Fed balance sheet is still having a modest impact on yields

·         Doesn't see the need for a rate cut in the near term

 

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 surged to almost record highs after than expected sequential decline in core/total CPI as the Fed may cut rates from Sep’24 (based on this report). But the Fed never goes for any rate action/change in stance based on a single month of CPI or employment report. Also, the overall core CPI trajectory or disinflation pace still fails to provide the necessary level of confidence to the Fed for any rate cut cycle decision.

On Wednesday, Wall Street was boosted by almost all major sectors led by techs, real estate, healthcare, utilities, communication services, banks & financials, industrials, materials, energy, and consumer staples to some extent. Script-wise, Wall Street was boosted by Salesforce, Amgen, Home Depot, Merck, Microsoft, Goldman Sachs, Cisco, Visco, Apple, Nvidia, Dell, and McDonald’s, while dragged by Walt Disney, Boeing, Travelers, Nike, Amazon and Chevron. Boeing tumbled amid reports that the Justice Department (DOJ) accused the company of violating a prior agreement to avoid prosecution related to the 737 Max crashes. GameStop and AMC slumped after a record rally.

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 40000/40200* and 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.