Dow, Gold wobbled on hotter US core PPI and mixed Fed talks

Wall Street Futures surged Thursday on hopes & hypes of an early Fed rate cuts after softer than expected US retail sales in January (after upbeat shopping/holiday season in Q4 and unusual cold weather in January). But the overall retail sales data is Goldilocks in nature, which may not change Fed’s planning for -75 bps rate cuts in H2CY24 amid steady disinflation. On Friday, the focus of the market was on U.S. core PPI (Producer Price Inflation) data after hotter-than-expected core CPI data published Tuesday.

As a recapitulation, Wall Street Futures, Gold tumbled Tuesday on fading hopes of an early & deeper Fed rate cut after hotter-than-expected core inflation data for January. But the overall core CPI inflation trend is in line with the Fed’s projections. Also as per some analysts/calculations, fine prints of sequential core CPI indicate that sequential core PCE inflation may be around +0.30%, which translates to +2.7% annual rate in Jan’24 against +2.9% in Dec’23 vs +3.9% core CPI inflation rate in Jan’24. In this way, the market is now gradually discounting the first rate cut by the Fed in July’24 from the prior May June ’24; the Fed may cut rates by 75-100 bps in H2CY24, starting from July’24, depending upon the actual core inflation data and overall economic outlook.

On Friday, oil got some boost on hopes of fresh economic sanctions on Russia/Putin after US President Biden  blamed Putin for the prison death of opposition leader Navalny and promised ‘some actions’. Biden said:

·         Putin is responsible for the Russian opposition leader Navalny's death.

·         I'm contemplating what else can be done against Russia, looking at a whole number of options

On Gaza war front, Israel-Hezbollah tensions are flaring up, while Israel is allegedly carried out a covert attack on two major Iran gas pipelines (heating and cooking gas). As per an Axios report Israel's President Herzog met secretly Friday on the sidelines of the Munich Security Conference with the PM of Qatar Al Thani, and discussed with him the talks for the release of the abductees in the Gaza Strip. US President Biden is also urging for a temporary ceasefire for release of all hostages. Israel is also seeking a complete exit of top Hamas leadership from Gaza as a part of any permanent peace/ceasefire two-state solution deal.

But Hamas is not ready for any such deal. On Friday, Hamas chief Ismail Haniyeh said the Palestinian group will not accept anything less than a complete cessation of the aggression, the withdrawal of the occupation army from Gaza, and the lifting of the unjust siege and Israel must also free Palestinian prisoners serving long sentences in any upcoming swap deal.

On Friday, the BLS flash data (NSA) shows U.S. core PPI surged +2.0% in Jan’24, from +1.7% sequentially and well above the market consensus of +1.6% and the first annual increase since Sep’23.

On a sequential (m/m) basis (SA), the U.S. core PPI surged +0.5% in Jan’24 from a fall of -0.1% in Dec’23 and much higher than the market expectations of +0.1% and the sharpest increase since July’23.

Overall, the sequential average rate of core PPI (SA) rate was around +0.14% in 2023 against +0.47% in 2022, while the annual core PPI (SA data) was around +2.9% in 2023 against +7.9% in 2022.

On Friday, the BLS data also shows U.S. annual (y/y) PPI eased to +0.9% in Jan’24 from +1.0% reading in Dec’23 and above market expectations of +0.6%. On a sequential (m/m) basis, the U.S. PPI rose 0.3% in Jan’24, from -0.1% decline in Dec’23 and the biggest increase since July’23, and above market forecasts of 0.1%. In Jan’24, cost of services rose 0.6%, the largest increase since July, led by a 2.2% gain in prices for hospital outpatient care. Cost of chemicals and allied products wholesaling, machinery and equipment wholesaling, portfolio management, traveler accommodation services, and legal services also moved higher. On the other hand, prices of goods declined 0.2%, the fourth consecutive drop, led by a 3.6% fall in gasoline. Prices for electric power; hay, hayseeds, and oilseeds; beef and veal; ethanol; and iron and steel scrap also moved lower.

Also, fine prints of BLS data shows US core personal consumption for PPI index, equivalent to core PCE increased around +0.5% in Jan’24 after +0.2% advance in Dec’23. If this trend/sequential rate of around 0.4-0.5% holds in Jan’24 data, the annual core PCE inflation would be around 2.8-2.9% from +2.9% against present market expectations of +0.3% sequential and +2.7% annual rate-may put question mark on present trend of disinflation.

On Friday, the UM (University of Michigan) flash data shows US 1Y inflation expectations edged up to +3.0% in February from a three year low of +2.9% in January, while 5Y inflation outlook remains same at+2.9%. The US/UM consumer sentiment increased to 79.6 in February from 79.0 sequentially, but slightly below market expectations of 80.0 amid cooling inflation and robust labor market (soft landing optimism).

The UM said: “Consumer sentiment was essentially unchanged from January, rising 0.6 index points this month and solidifying the large gains from the past two months. The fact that sentiment lost no ground this month suggests that consumers continue to feel more assured about the economy, confirming the considerable improvements in December and January across various aspects of the economy. Consumers continued to express confidence that the slowdown in inflation and strength in labor markets would continue”.

On Friday, the Atlanta Fed GDPNow estimate for Q1CY24 US real GDP growth remains unchanged at 2.9% after a week of various economic data including retail sales.

On Friday, Fed’s Bostic said:

·         I expect more progress on inflation but could be bumpy

·         Fed is likely to consider rate cuts soon but doesn't face urgency

·         U.S. economy less sensitive to interest rate changes

·         The US economy is in a good place

·         Inflation at 2% remains elusive

·         Economic Risks are Now More Balanced

·         January CPI not signaling a significant change in the trend of weakening inflation

·         Expects inflation to drop at a slower rate than what markets anticipate

·         Sees Fed making solid progress in lowering inflation

·         Fed is not urged to cut rates amid current economy

·         A strong economy justifies waiting to adjust monetary policy

·         Red Sea disruptions haven't much affected the US so far

·         If the economy performs well, I'm OK with waiting longer to cut

·         I was a little surprised by the January CPI report

·         My outlook is to start lowering rates in the summertime. I still expect two rate cuts in 2024

On Friday, Fed’s Daly said:

·         I do not see CRE being an imminent risk to financial stability

·         We can't wait for inflation to reach 2% before cutting rates

·         I don't agree with the idea that the last leg of inflation will be the hardest

·         I'm not expecting disruptions from QT, appropriate to plan

·         The Fed wants to convey a single stance of policy with rates and balance sheet. The Fed does not want to go past ample reserves

·         The policy is working; we have to see how much longer it will take to get the job done

·         The neutral rate estimate is now between 0.5 and 1, with a nominal rate between 2.5 and 3

·         The expectation is that in an uncertain world, the Fed can take a gradual approach to policy decisions

·         The labor market is cooling, but so far it represents a return to balance as hiring becomes easier in some sectors. I don't see an imminent weakening in the job market

·         The Fed's challenge is that the labor market is good until it is not; need to look at other data

·         It's premature to think about just letting the economy run

·         Business contacts are not clamoring for rate cuts but want the decline in inflation to continue

·         Three cuts are a reasonable baseline for the year

·         Expectations for the economy remain close to where they were in December when most recent projections were set

·         I'm seeing ongoing progress on inflation that will move around month to month

·         All of the recent reports are within the bounds of recent volatility, and turning points are always bumpy

·         None of the recent data was surprising

·         We need more time and data to be sure of continued progress on inflation

·         Risks ahead include slower inflation progress & a faltering labor market

·         The Fed needs to resist the temptation to act quickly when patience is needed

·         There's more work to do on inflation

·         Remarkable progress on inflation is not a victory

·         Slowing inflation, without significant a decline in unemployment, is unequivocally good news

·         With positive data, I could support 3 cuts this year

·         I want to be careful about pushing balance sheet cuts (QT) too far

·         I was a little surprised by the January inflation data, but not in a big way

·         I don't see the market's urgency over lowering rates

·         The economy has lots of positive news

·         The economy still has tremendous momentum

·         I still expect two rate cuts in 2024

·         I am willing to pull the timing of rate cuts forward if data calls for it

·         My outlook is to start lowering rates in the summertime

·         I still expect the trend back to 2% inflation to be intact

·         People are feeling OK about the state of the economy

·         There's still more work to do to lower inflation pressures

·         I can live with the recent inflation data, the Fed should be patient on policy

·         I was a little surprised by the data (Jan’24 core CPI), but I have seen a lot of progress in inflation

·         Fed needs to resist the temptation to act quickly when patience is needed

On Friday, Fed’s Barr said:

·         I want to be flexible in conducting the Fed stress tests

·         Supervisors closely focused on commercial real estate risks

·         Regulators have downgraded bank ratings at a faster pace

·         The Fed is still exploring whether to require temporary higher capital and liquidity requirements for firms with trouble managing risk

·         Bank supervisors are closely focused on commercial real estate risks

·         Bank supervisors have issued more findings and downgraded bank ratings at a higher rate in the past year

·         Examiners conducting additional examinations of firms with large unrealized losses or other vulnerabilities

On Friday, Fed’s Barkin said:

·         CPI data confirms why the Fed needs more confidence to cut

·         January economic data has been messy, and not that good

On Friday, Fed’s Daly and Bostic sounded less hawkish, but overall Fed is preparing the market for an eventual cycle of rate cuts (75-100 bps) in H2CY24. The market (Fed Swaps) now assigns lower odds to May and June rate cuts and is gradually discounting first rate cut from July’24.

Conclusions:

The 12M average between the US core CPI and core PCE inflation is now around +4.5%, which the Fed may consider as underlying core inflation, the target of which is +2.0% on a durable basis. The 6M rolling average of core inflation (PCE+CPI) is now around +3.9% or around +4.0%.

Fed may cut 75-100 bps in H2CY23 if the 6M rolling average of core inflation (PCE+CPI) indeed eased further to +3.0% by H1CY24.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(4.50.00-2.00) =0+2+2.50=4.50% (for 2024)

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation for CY23

Fed has to ensure a 2% price stability (core inflation) target keeping the unemployment rate below 4% and also 10Y bond yield below 5.00-4.50% so that borrowing cost for Uncle Sam remains manageable/sustainable to fund +34T debt (never-ending).

In any way, at the current run rate and trend, the average US core PCE inflation should be around +4.0% in 2023, +2.5% in 2024, +2.1% in 2025, and +1.5% in 2026, in line with Fed’s Dec’23 SEP. Similarly, the U.S. core CPI inflation average should be around +4.6% in 2023, +3.2% in 2024, +2.5% in 2025, and +1.8% in 2026.

If US core CPI indeed dips below +3.0% by May-June’24 and if it seems that the 2024 average core inflation will be around +3.2%, then the Fed may start cutting rates from July’24 and may cut cumulatively 75 bps at -0.25% pace till Dec’24 for a repo rate at 4.75%, so that core real rate continues to stand around +1.50%, in line with the present restrictive stance (5.50% repo rate-4.00% average core CPI for last 6M).

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut (dovish jawboning) from Mar’24 (Q1CY24) to ensure a soft landing while bringing down inflation. Also, whatever the narrative, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 15% of its revenue as interest on public debt against China/EU’s 5.5%.

As a result of higher bond yields around 4.50%-5.00% (for 10Y UST); i.e. lower bond prices, the Fed is now in deep MTM loss for its huge bond holding. Fed is also providing higher interest to banks & financials for reverse repo operation than it getting under repo operation; i.e. Fed’s NIM/NII is now negative and theoretically the Fed is in negative profit to the tune of -$130B. The same is also true for various banks & financials, most of which are now in deep MTM loss for higher bond yields; i.e. lower prices for their HTM bond portfolio holdings due to Fed hikes. The US10Y TSY market price fell from around $140 to $105 from Jan’20 (pre-COVID) to mid-Oct’23; i.e. a fall of almost -33% in around 4 years; it recently recovered to almost $113 levels.

This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price & financial stability and soft-landing. Fed has to bring down inflation to +2.0% targets by the  US 10Y bond yield below 4.50-5.00%, and an unemployment rate below 4.0% without triggering an all-out or even a brief recession in the US Presidential election year (Nov’24). The Fed will ensure that the US10Y bond yield is below 4.50-5.00% at any cost for lower borrowing costs for Uncle Sam (U.S.), everything being equal. Thus, overall Fed is methodically jawboning on both sides (hawkish/dovish) from time to time to achieve all its goals at the same time.

Considering all pros & cons, Fed may wait for core inflation data (average for core PCE and core CPI) for at least Dec’23-Mar’24 and if it goes down to around +4.00% from the projected 2023 average of +4.5% (4.80% core CPI and +4.20% core PCE), the Fed may cut rep rates/FFR by -25 bps in July; further if such disinflation trend continues, Fed may cut -25 bps each in September and December for a cumulative -75 bps.

We may see a synchronized global easing from H2CY24. As the Fed is the world’s unofficial central bank because the USD is the ‘King’ (the world’s most preferred FX or global reserve currency), all major G20 central banks are now bound to follow the Fed policy stance to maintain present policy/currency/bond yield parity, everything being equal.

Thus the market is now expecting a synchronized global easing (rate cuts) by major G20 global central banks including ECB, BOE, BOC, PBOC, and even India’s RBI, whatever may be the domestic macro-economic narrative (just like post-COVID synchronized global tightening to bring inflation down to targets).

Fed policymakers will now jawbone the market in a balancing way to keep the US10Y bond yield between the 3.25-5.25% range or around 4.00-4.50% on an average to maintain price/labor market/financial (Wall Street) and also Main Street/White House stability in the election year (2024). As the U.S. labor market is still robust with healthy wage growths, the incumbent Biden admin may prefer price stability and lower inflation in the coming months along with a sub/below 4% unemployment rate; i.e. price stability over GDP growths. As the 10Y bond is the main instrument for raising debt and a benchmark for US/global borrowing costs, the Fed may not allow it to hover above 5.00% for long under any circumstances, everything being equal. Fed needs to lower borrowing costs for the U.S. government from the present 15% to 10-7% over the next few years.

Fed hiked rate last in July’23 for a +5.50% repo rate and in hold mode with a hawkish stance since Aug’23; subsequently, US10Y bond yield gradually surged from around +3.75% to +5.00% by late November. As a result of higher borrowing costs and tighter financial conditions, the demand of the economy was affected to some extent, resulting in lower inflation. Now Fed has to keep on hold (neutral mode) for at least 10-12 months from July’23, so that the impact of higher borrowing costs is gradually transmitted to the real economy in full, resulting in core inflation back to targets.

Thus Fed has to wait till at least July’24 for the expected 1st rate cut; otherwise, its credibility may be at stake. If the US10Y bond yield again falls below +3.0% in the coming days (from the present +3.95%), then it may cause less restrictive financial conditions, resulting in higher core inflation. Thus Fed has to jawbone the market so that the US10Y bond yield hovers around 4.0-4.50% in the coming days so that the Fed can ensure relatively lower borrowing costs and price stability (soft landing).

Fed has to ensure 2% price stability and below 4% unemployment targets along with financial/Wall Street Stability and also keeping public/government borrowing costs at the lowest possible by directly/indirectly controlling bond yield (like YCC by BOJ). Fed is now targeting 2% core inflation with below 4% unemployment and 4.50% bond yield (10Y US) to keep borrowing costs lowest for the Government.

Bottom Line:

Fed, ECB may cut rates from July’24; i.e. in H2CY24 for a cumulative 75-100 bps (synchronized global rate cuts amid a synchronized easing in core inflation); every major central bank including PBOC has to follow ‘King Fed/USD’, whatever may be the narrative.

Market wrap:

On Friday, Wall Street Futures, Gold tumbled after hotter than expected core PPI data and possible hotter core PCE data to be published in the month end; Fed will eventually set policy rate on average core inflation (PCE+CPI) and employment data. Dow Future tumbled by almost -200 points to 38652 but eventually recovered to an almost life time high around 38909 and again stumbled to close around 38654 amid softer-than-expected housing starts, building permits, consumer sentiment, hotter-than-expected inflation expectations data and mixed/less hawkish Fed talks. Gold initially slip from around 2008 to 1995, but soon recovered to 2015 before closing around 2010; the S&P 500 lost -0.5%, the Dow dropped -145 points, while Nasdaq slid -0.8%.

On Friday, Wall Street was dragged by communication services, real estate, techs, industrials, consumer discretionary, banks & financials, utilities,  and energy to some extent, while boosted by materials, healthcare and consumer staples. AMD soared after the company's earnings, revenue, and guidance topped estimates. On the other hand, DoorDash tumbled after reporting a higher-than-expected loss.

On Friday, Wall Street was dragged by tech majors amid higher bond yield as the US10Y bond yield scaled almost +4.35%, at a 75-day high; Meta, Nike, Amgen, Cisco, Intel, 3M, Apple, Microsoft and also Boeing, Caterpillar, JPM, Walgreens Boots and Verizon slumped. But Wall Street was also boosted by Merck, Walmart, IBM, Home Depot, P&G, United Health, and Chevron to some extent. For the week, the S&P 500 and the Nasdaq lost 0.4% and -1.5%, and the Dow Jones inched lower by -0.2%.

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

Whatever may be the narrative, technically Dow Future (38656), now has to sustain over 39200 levels for a further rally to 39500/39900-40200/40500 and even 42600  levels in the coming days; otherwise, sustaining below 39150/39000-38950/38600 levels may again fall to 38400/38200*-38000*/37300 levels in the coming days.

Similarly, NQ-100 Future (17745) now has to sustain over 18000-18200 levels for a further rally towards 18500/18675-18975/19200 and 19450/19775-2000/20200 in the coming days; otherwise, sustaining below 17950 may again fall to 17750 17375/16390 in the coming days.

Also, technically Gold (XAU/USD: 2013) now has to sustain over 2025 for any further rally to 2035-2065; otherwise sustaining below 2020, may again fall to 2010/2000-1995/1985-1975 and even 1950 may be on the card.