Dow recovered on the Fed’s soft landing and pivot optimism

On Wednesday, apart from ongoing Israel-Gaza war tensions, all focus of the market was also on the Fed’s policy decision, where the Fed was expected to hold the rate with an indication of at least another hike in the coming months; i.e. hawkish hold stance. Overall, Wall Street Futures and Gold slumped, and USD jumped to some extent as the Fed’s statement kept open the option of at least another hike in the coming months, without indicating any rate cuts at least till H1CY24.

On Wednesday, Wall Street slipped initially after a hawkish hold by the Fed for the 2nd consecutive time, keeping the door open for at least another hike. Chair Powell also reiterated that the FOMC had not discussed any rate cuts yet, while the primary focus remains on whether the Fed will need to implement additional rate hikes.

On Wednesday, Gold ‘slips’ from around 1982 to 1969 after Fed Chair Powell said the Fed is not sure that it has reached sufficiently restricted policy space: “We are not confident policy is sufficiently restrictive.” But Gold again ‘surged’ to around 1982 after Powell indicated Fed was very close to the rate hike cycle end: “We have come very far with this rate-hike cycle and are close to end of the cycle.” Dow Future also surged from around 33134 to 33416; but overall the market was almost flat as Fed/Powell delivered another hawkish hold stance, largely expected by the market (higher for linger policy in 2024).

On Wednesday, the U.S. Fed held all primary policy rates as unanimously expected; i.e. the target range for the Federal Fund's Rate (FFR-interbank rate) at +5.38% (5.25%-5.50%); primary credit rate (repo rate) at +5.50%; IOER (reverse repo rate) at +5.40%; overnight repurchase agreement rate (RP) at +5.50% and RRP (Overnight Reverse Repurchase Agreement Rate) at +5.30%, keeping U.S. borrowing costs to the highest level since January 2001 (22-years); as US core inflation is still quite elevated at around +4.0%, while the unemployment rate continues to be around historical low, at 3.8% and below Feed’s longer-term sustainable target of 4.0%. Fed/Powell also pointed out that as bond yield is now quite elevated around +5.00% (10Y UST), it’s helping in tighter financial conditions and may be equivalent to another +25 bps rate hike. Thus there is a need for a pause by the Fed to assess the underlying economic conditions and the need for any further hikes or not.

Highlights of Fed’s statement: 1st November’2023

·         US Interest Rate Decision Actual 5.5% (Forecast 5.5%, Previous 5.5%)

·         We will continue bond-holding reductions as previously planned

·         Economic activity expanded at a strong pace in the third quarter, and job gains moderated but remained strong

·         We are prepared to adjust policy stance as appropriate if risks emerge to achieving its goals

·         Inflation remains elevated, and the policy-setting committee is strongly committed to returning inflation to the 2% target

·         Tighter financial and credit conditions are likely to weigh on economic activity, hiring, and inflation, but the extent of the effects remains uncertain

Full text of Fed’s statement: 1stNovember’2023- Federal Reserve issues FOMC statement

“Recent indicators suggest that economic activity expanded at a strong pace in the third quarter. Job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy. In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

In addition, the Committee will continue reducing its holdings of Treasury securities agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Adriana D. Kugler; Lorie K. Logan; and Christopher J. Waller.”

Implementation Note issued November 1, 2023: Decisions Regarding Monetary Policy Implementation

“The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on November 1, 2023:

The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate paid on reserve balances at 5.4 percent, effective November 2, 2023.

As part of its policy decision, the Federal Open Market Committee voted to direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:

"Effective November 2, 2023, the Federal Open Market Committee directs the Desk to:

Undertake open market operations as necessary to maintain the federal funds rate in a target range of 5-1/4 to 5-1/2 percent.

Conduct standing overnight repurchase agreement operations with a minimum bid rate of 5.5 percent and with an aggregate operation limit of $500 billion.

Conduct standing overnight reverse repurchase agreement operations at an offering rate of 5.3 percent and with a per-counterparty limit of $160 billion per day.

Roll over at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing in each calendar month that exceeds a cap of $60 billion per month. Redeem Treasury coupon securities up to this monthly cap and Treasury bills to the extent that coupon principal payments are less than the monthly cap.

Reinvest into agency mortgage-backed securities (MBS) the amount of principal payments from the Federal Reserve's holdings of agency debt and agency MBS received in each calendar month that exceeds a cap of $35 billion per month.

Allow modest deviations from stated amounts for reinvestments, if needed for operational reasons.

Engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS transactions."

In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve the establishment of the primary credit rate at the existing level of 5.5 percent.

This information will be updated as appropriate to reflect decisions of the Federal Open Market Committee or the Board of Governors regarding details of the Federal Reserve's operational tools and approach used to implement monetary policy.”

Full text of Fed Chair Powell’s opening statement: 1st November’2023:

My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people. We understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2 percent goal. Price stability is the responsibility of the Federal Reserve. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.

Since early last year, the FOMC has significantly tightened its stance on monetary policy. We have raised our policy interest rate by 5-1/4 percentage points and have continued to reduce our securities holdings at a brisk pace. The stance of policy is restrictive, meaning that tight policy is putting downward pressure on economic activity and inflation, and the full effects of our tightening have yet to be felt.

Today, we decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings. Given how far we have come, along with the uncertainties and risks we face, the Committee is proceeding carefully. We will make decisions about the extent of additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks.

I will have more to say about monetary policy after briefly reviewing economic developments.

Recent indicators suggest that economic activity has been expanding at a strong pace, and well above earlier expectations. In the third quarter, real GDP is estimated to have risen at an outsized annual rate of 4.9 percent, boosted by a surge in consumer spending. After picking up somewhat over the summer, activity in the housing sector has flattened out and remains well below levels of a year ago, largely reflecting higher mortgage rates. Higher interest rates also appear to be weighing on business fixed investment.

The labor market remains tight, but supply and demand conditions continue to come into better balance. Over the past three months, payroll job gains averaged 266 thousand jobs per month, a strong pace that is nevertheless below that seen earlier in the year. The unemployment rate remains low, at 3.8 percent. Strong job creation has been accompanied by an increase in the supply of workers: The labor force participation rate has moved up since late last year, particularly for individuals aged 25 to 54 years, and immigration has rebounded to pre-pandemic levels. Nominal wage growth has shown some signs of easing, and job vacancies have declined so far this year. Although the jobs-to-workers gap has narrowed, labor demand still exceeds the supply of available workers.

Inflation remains well above our longer-run goal of 2 percent. Total PCE prices rose 3.4 percent over the 12 months ending in September. Excluding the volatile food and energy categories, core PCE prices rose 3.7 percent. Inflation has moderated since the middle of last year, and readings over the summer were quite favorable. But a few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal. The process of getting inflation sustainably down to 2 percent has a long way to go. Despite elevated inflation, longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.

The Fed’s monetary policy actions are guided by our mandate to promote maximum employment and stable prices for the American people. My colleagues and I are acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. We are highly attentive to the risks that high inflation poses to both sides of our mandate, and we are strongly committed to returning inflation to our 2 percent objective.

As I noted earlier, since early last year, we have raised our policy rate by 5-1/4 percentage points, and we have decreased our securities holdings by more than $1 trillion. Our restrictive stance on monetary policy is putting downward pressure on economic activity and inflation. The Committee decided at today’s meeting to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent and to continue the process of significantly reducing our securities holdings. We are committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation sustainably down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective.

We are attentive to recent data showing the resilience of economic growth and demand for labor. Evidence of growth persistently above potential or that tightness in the labor market is no longer easing could put further progress on inflation at risk and could warrant further tightening of monetary policy.

Financial conditions have tightened significantly in recent months, driven by higher longer-term bond yields, among other factors. Because persistent changes in financial conditions can have implications for the path of monetary policy, we monitor financial developments closely.

In light of the uncertainties and risks, and how far we have come, the Committee is proceeding carefully. We will continue to make our decisions meeting by meeting, based on the totality of the incoming data and their implications for the outlook for economic activity and inflation as well as the balance of risks.

In determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

We remain committed to bringing inflation back down to our 2 percent goal and to keeping longer-term inflation expectations well anchored. Reducing inflation is likely to require a period of below-potential growth and some softening of labor market conditions. Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the long run.

To conclude, we understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission. We at the Fed will do everything we can to achieve our maximum employment and price stability goals. Thank you, and I look forward to your questions.”

Highlights of Fed Chair Powell’s comments in the Q&A: 1st November’2023:

·         There's a long way to go to get inflation to 2%

·         A few months of good inflation data is only the beginning of what it will take

·         Inflation has moderated since the middle of last year

·         Labor demand still exceeds supply

·         Nominal wage growth has shown some signs of easing

·         Job gains are at a strong pace but less than earlier

·         Supply and demand conditions for labor continue to come into better balance

·         The labor market remains tight

·         The economy has expanded well above expectations

·         We will make decisions on the totality of data and the balance of risks

·         Given how far we have come and amid uncertainty we are moving carefully

·         The full effects of tightening are yet to be felt

·         The stance of policy is restrictive

·         Without price stability, the economy doesn't work for anyone

·         The restrictive stance of policy is putting downward pressure on inflation

·         We are committed to achieving a sufficiently restrictive stance

·         We are attentive to recent data showing the resilience of economic data and demand for labor. These could put further progress on inflation at risk

·         Reducing inflation is likely to require below-potential growth, labor conditions softening

·         In determining if we need more firming, we will take into account cumulative tightening, lags, and economic and financial developments

·         There's a long way to go to get inflation to 2%

·         A few months of good inflation data is only the beginning of what it will take

·         Inflation has moderated since the middle of last year

·         Labor demand still exceeds supply

·         Nominal wage growth has shown some signs of easing

·         Inflation has been coming down but is still well above the target

·         We are not confident policy is sufficiently restrictive

·         We are attentive to an increase in longer-term yields; it can have implications for monetary policy

·         Tighter financial conditions from higher long-term rates, a stronger dollar, and lower stocks could matter for future rate conditions

·         Longer-term higher rates can't be a reflection of higher policy rates (alone) from us, those changes would also have to be material

·         It does not appear that an expectation of higher Fed policy rates is causing higher longer-term rates

·         We have not made any decisions on future meetings

·         The idea that it would be difficult to raise again after pausing is not right

·         Financial conditions have clearly tightened

·         The Fed staff didn't put a recession back into their forecast at this meeting

·         It's tough to translate how many rate hikes the tighter financial conditions translate to

·         Over time that will have an effect, we just don't know how quickly that will be

·         We see the effects of higher rates on the housing market, surveys on durables buying

·         We look at the labor market, economic growth, and financial conditions

·         If we reach a judgment we need to tighten, we will

·         We are not thinking about rate cuts right now at all

·         Rate cuts just haven't come up

·         The next question will be how long to keep the policy restrictive

·         The question we are asking is, should we hike more?

·         The bigger picture is we are making progress on the labor market, and inflation, and are very focused on getting policy sufficiently restrictive

·         A government shutdown is a potential source of risk

·         There is plenty of risk out there

·         The FOMC is monitoring closely Middle East geopolitics for economic implications

·         We still believe colleagues that we will likely need to see slower growth, softening in labor market conditions

·         Supply-side gains have been helping, but those things will run their course

·         We have to make policy under great uncertainty

·         We are seeing the effects of 2022 rate hikes now

·         QT may be playing a relatively small role in the rise in longer-term rates

·         We are not considering changing the pace of balance sheet runoff

·         The policy is restrictive and we see its effects

·         We have come very far with this rate-hike cycle and are close to the end of the cycle

·         We are proceeding carefully

·         We have to make policy under great uncertainty. This is one reason we have slowed the process down this year, can't rush it

·         If we reach a judgment we need to tighten, we will

·         Reserves are not even close to scarce at this point

·         Failing to control inflation, risks higher inflation expectations

·         It's clear that inflation expectations are in a good place

·         Within a range of estimates of the neutral rate, the policy is restrictive

·         Wage increases have come down significantly over the last 18 months, in line with pre-COVID levels, consistent with a +2.0% inflation target

·         Wages are not the principal driver of inflation so far.

·         In the future, it may be that the labor market becomes more important for inflation

·         Now we've reached a point where risks are getting more balanced between doing too much or too little

·         It's not clear that conflict in the Middle East is on track to have an economic impact on the United States

Conclusion:

The Fed will be on hold with a hawkish stance in December too and hold the same at least till Sep’24; the Fed tightening cycle is now almost over (if there is no abnormal surge in core inflation in the coming months)

The average sequential rate for U.S. core CPI (seasonally unadjusted) was around +0.11% in 2020, +0.45% in 2021-22, and estimated +0.35% in 2023. At a current average sequential rate of +0.25% in the last few months, the annual core CPI should be around +4.3% in Dec’23 against +5.7% in Dec’22.

Looking ahead, if the rate of average sequential core CPI further declines to around +0.25% in 2024 and +0.15% in 2025, then the annual core CPI would be around +3.0% by Dec’24 and +2.0% by Dec’25-in line with Fed’s present projections. Thus there is a need for a higher restrictive rate for longer policy at least till Sep’24. By Sep’24, U.S. core CPI should be around +3.0% and then the Fed may go for rate cuts of at least -50 bps a quarter.

Thus Fed is preparing the market for a hawkish hold stance in H1CY24 with an end to the current tightening cycle. Fed may go for a hawkish hold policy action/stance amid excuses of Israel-Hamas war/simmering ME geopolitical tensions and rising 10Y US bond yield. But the Fed may continue to project at least another hike in December and one hike in H1CY24 (March/June) to continue its hawkish hold stance and to ensure tighter financial conditions and also Fed credibility. The Fed is now preparing the market for higher for longer policy.

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)*(5.50.00-2.00) =0+2+3.50=5.50%

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 (CPI+PCE) =5.50% (for 2022); H1CY23 average core inflation around +5.40% (~5.50%)

Fed may not hike further, keeping the terminal repo rate at +5.50% with a hawkish hold stance at least till H1CY24. Similarly, ECB and BOE will continue to be on hold with a hawkish bias at +4.75% and +5.50% respectively; i.e. we have a synchronized global hawkish hold stance by major G4 central banks (Fed, ECB, BOE, and BOC) to ensure tighter financial conditions, lower demand/economic activities and lower inflation expectations/lower inflation.

 

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, 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 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. 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 stability and soft-landing.

Market wrap:

On early Wednesday, the US bond yield/USD, Gold eased to some extent, while stocks got some boost on treasury plan to borrow less than expected and easing of Israel-Hamas/Gaza war tensions. But softer ADP private payroll data also boosted Wall Street futures and Gold briefly. But eventually, Wall Street Futures recovered on Fed pause/pivot and soft landing optimism coupled with ease of Gaza war tensions as Israel may soon call for a humanitarian ceasefire amid increasing global pressure including the U.S.

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

Whatever the narrative, technically Dow Future (33450), now has to sustain over 33550 for any further rally to 33750 and 33900/34300-34450/34855 and further to 35375-35875 in the coming days (if there is a Gaza ceasefire/Israel ends its intensifying surgical/military operation).; otherwise, if there is a further escalation in Gaza war tensions, Dow Future may further fall below 33500 for 33100-32200 and 32000/31750-31595/31190 and even 29400-28475 levels (in case of a wider major regional military conflict).

Similarly, NQ-100 Future (14850), now has to sustain over over14950 for any further rally to 1510/150-15325/15500 and further 15625/15750-15975/16075 in the coming days; otherwise sustaining below 14900, NQ-100 may again fall to 14800/14600-14450/14300-14200/14100 and 14000/13800-13650/13500-13395/12990 and 12790/12400-12180/11650 and even 11000-10675 in the coming days.

Technically, Gold (XAU/USD: 1990) now has to sustain over 2012 for a further rally to 2022/2038-2055/2085; otherwise sustaining below 2005-1995/90 may further fall to 1997/1980-1975/1955 and 1945/1934-1924/908 and further 1894-1805 in the coming days.