Dow slip from China boost as US core PCE disinflation stalled

·         The projected Fed rate cut of 50 bps in Dec’24 may not be assured as the US core disinflation pace may have stalled in Q3CY24; Fed may cut 25 bps

·         If US unemployment remains around 4.0%, the Fed may not go for consecutive rate cuts; the Fed may pause in Nov’24 before going for a December’24 rate cut

·         Overall, in Aug’24, the annual revision affected the PCE and core PCE index right from 2018; if there was no such revision, the sequential rate would be around 0.2 or 0.3%

Wall Street Futures led by DJ-30 and SPX-500 scaled a new life time high (LTH) on hopes & hopes of bigger Fed pivots/rate cuts. But tech-savvy NQ-100 underperformed to some extent due to the growing tech war between the US and China (domestic political compulsion ahead of the US election). But Wall Street Futures, Metals, and even oil were also boosted by China's PBOC stimulus plan to boost not only real estate but also the overall economy from years of slumber, especially after the Trump trade war tantrum and followed by COVID conspiracy. The Chinese economy may be now suffering from excess capacity, lower demand, and a subsequent deflation-like scenario. Export-heavy China is suffering from weak global demand/trade and also subsequently subdued domestic demand, resulting in abnormally lower inflation or deflation-like scenarios.

On early Friday (as previously announced Tuesday), China’s PBOC cut the reserve requirement ratio (RRR) for banks by -50 bps, the second reduction this year aimed at bolstering a sluggish economy. The change will bring down the weighted average RRR to 6.6%. This move will free up about CNY 1 trillion in new lending, with the central bank leaving room for another cut this year. Additionally, the PBOC trimmed the 7-day reverse repo rate by -20 bps to 1.5%. This rate is used to determine the nation's key lending rates. It also stated interest rates for 14-day reverse repos, as well as temporary repos and reverse repos, will continue to be adjusted in line with changes to the 7-day reverse repo rate.

China has ramped up the rollout of policy initiatives this week, with its top decision-making body, the Politburo, pledging to introduce further fiscal and monetary support measures to prevent further deterioration of the economy. Subsequently, Chinese stocks, which had been underperforming Wall Street for a long, joined the bandwagon for a synchronized global rally amid synchronized global easing. Chinese stock market soared to a 12-month high and had the best week since 2008. Chinese stock market may also soon scale a fresh life time high in line with global peers amid a global easing boost. There would be multiple rate cuts by the Fed, ECB, BOE, and other major G20 Global central banks. But Chinese monetary and fiscal stimulus might be measured, targeted and limited in nature.

On Friday, some focus of the market was also on U.S. Core PCE inflation, the Fed’s preferred gauze to measure underlying inflation trends. The BEA flash data showed U.S. annual (y/y) core PCE inflation (Seasonally Adjusted-SA) for August ticked up to +2.7% from +2.6% sequentially, in line with the market expectations of +2.7% and remained stalled at its lowest zone since Mar’21 (three years) for the three consecutive months (May-June-July). The US core PCE inflation now stalled at around +2.6% since May after being stalled at +2.8% before that for three months (Feb-Mar-Apr’24) and now again ticked up to +2.7% in Aug’24.

On a sequential (m/m) basis (seasonally adjusted) the U.S. core PCE inflation was increased by +0.1% in Aug’24 against +0.2% in the prior month and lower than the market expectations of +0.1%. The Fed needs the sequential average core PCE inflation running around +0.1% (between 0.2-0.0.0%) consistently for its price stability target of annual core PCE inflation around +1.5%.

In Aug’24, the U.S. super core PCE service inflation ex Housing/Shelter, (the current focus of the Fed) was unchanged at +3.3% from +3.3% (y/y). The US super core PCE service inflation was around +2.0% in pre-COVID days.

Overall, after the latest annual/regular revisions, the 6M rolling average (6MRA) of US core PCE inflation was around +2.7% in Aug’24 against +2.7% in the prior month/report. The YTM-2024 average core PCE inflation was around +2.8% in Aug’24 against +4.2% in 2023 (vs +4.1% before the latest annual revisions). The 6MRA sequential core PCE inflation was around +0.2% unchanged from the previous report, but the overall 2024-YTM sequential rate is now +0.2% against earlier +0.3% (before the latest annual revisions, affecting data from 2018 onwards).

The Q2CY24 average was around +2.7% vs the Q1CY24 average of +3.0%. Overall, for 2023, US core PCE inflation decreased from 4.9% to 3.0%; i.e. 1.9% over eleven months at an average disinflation rate of around -0.17% per month on average. In 2024, so far the US core PCE inflation further decreased from 3.1% in January to 2.7% in July; i.e. only 0.4% over 7 months; i.e. an average disinflation rate of around -0.06% per month.

The pace of disinflation in US core PCE inflation has been slowed down in 2024 from the unexpected pace in 2023. Overall, US core PCE inflation needs to go around 1.5-1.6% from present levels of +2.7%; i.e. around 1.0% for Fed’s price stability target. At present disinflation rate of -0.05% per month on average, it may take almost 20 more months; i.e. around Mar’26 for US core PCE inflation to fall around +1.50% on a sustainable basis.

On Friday, the BEA flash data showed U.S. annual (y/y) total PCE inflation (Seasonally Adjusted-SA) for August increased by +2.2% against +2.5% sequentially, below the market expectations of +2.3% and the lowest since Mar’21.

On a sequential (m/m) basis (seasonally adjusted) the U.S. total PCE inflation was increased by +0.1% in Aug’24 against +0.2% in the prior month and lower than the market expectations of +0.2%.

Overall, after the latest annual/regular revisions, the 6M rolling average (6MRA) of US PCE inflation was around +2.5%. The YTM-2024 average core PCE inflation was around +2.6% in Aug’24 against +3.8% in 2023. The 6MRA sequential PCE inflation was around +0.2%, the same as the 2024-YTM sequential rate.

In Aug’24, goods PCE inflation contracted -0.9%  from -0.2%, and service inflation was unchanged at +3.7%.

In August, the BLS data shows the US super core CPI inflation (w/o food, fuel/energy, shelter/housing, used cars & trucks) ticked down to +2.3% against +2.4% and Dec’19 (pre-COVID price stability) levels of +1.7%.

The Fed usually goes by a 6M rolling average (6MRA) of core inflation (PCE+CPI) for any important policy move. After the latest annual/regular revisions, the 6MRA of US core inflation (CPI+PCE) is now around +3.1% (vs +3.2% in the previous report), still above 1.1% above the Fed’s +2.0% targets, against 6MRA of unemployment rate 4.0%, the levels which Fed usually considers minimum unemployment; i.e. maximum employment (96% of the available work/labor force), sustainable in the longer run. But the Fed also considers a 3.5% unemployment rate as the lowest (green line), below which there may be a risk of deflation, while a 4.5% unemployment rate may be a red line for the Fed, above which there would be a risk of an all-out economic slowdown or even a recession (if sustained over a few months).

In brief, for the achievement of dual mandate (price stability and maximum employment), the Fed now needs to bring down 6M rolling average core inflation (PCE+CPI) to around +2.0% from the present +3.1% without allowing the average unemployment rate materially above 4.0%. If the unemployment rate surges above 4.5%, then the Fed may go for a more rapid dialing back of the restrictive rate, while 3.5% unemployment levels would be consistent with +2.0% core inflation price stability targets and 3.00-2.75% longer-term Fed terminal/neutral rate.

Although the Fed targets +2.0% core PCE inflation officially as a price stability mandate, in reality,/usually it’s +1.5% on average due to a 0.5% lower spread with core CPI inflation. Fed's price stability TGT is just below 2.0% inflation on a durable basis; the Fed generally targets average core inflation (PCE+CPI) +1.9%-as core PCE inflation is generally -0.5% lower than core CPI, Fed normally targets 1.5% core PCE and 2.3% core CPI for average core inflation at around +1.9%.

Thus Fed's average (6MRA) targets for the dual mandate:

·         CORE PCE INFLATION: +1.5%

·         CORE CPI INFLATION: +2.3%

·         UNEMPLOYMENT RATE: 4.0% (LOWER TGT: 3.5%; RED LINE: 4.5%)

·         FED'S LONGER TERM TERMINAL/NEUTRAL RATE: +3.0% OR +2.75% vs +2.50% pre-COVID days

In the US, Core CPI (Consumer Price Index) and Core PCE (Personal Consumption Expenditures) are two different measures of inflation used to gauge price changes in the economy as well as any change in consumer consumption behavior after any meaningful change of prices (excluding food and energy prices due to their volatility).

The key differences between US Core CPI and Core PCE inflation are:

·         Core CPI measures the change in the prices of a fixed basket of goods and services purchased by households (out of pocket), while Core PCE measures the change in prices of variable goods and services consumed by individuals, both excluding food and energy

·         Core CPI focuses on the price changes of a fixed basket of goods and services typically consumed by urban households, while Core PCE has a broader scope, including all goods and services consumed by households, and adjusts for changes in consumer behavior in line with any significant changes in price (e.g., substitution effects)

·         The Core PCE, on the other hand, includes a broader range of expenditures. It accounts not only for out-of-pocket expenses but also for various goods and services paid for by third parties, such as employer-provided health insurance. This means that the PCE captures a wider array of consumer spending and includes expenditures by non-profit institutions as well.

·         The CPI uses a specific Laspeyres formula, which is based on a fixed basket of goods. This means it does not adjust for changes in consumer behavior in response to price changes. For example, if the price of beef rises, the CPI does not account for consumers switching to chicken.

·         The PCE employs a Fisher ideal index formula, which allows for substitutions between items as their relative prices change. This flexibility typically results in a smoother inflation rate, as it reflects changing consumer preferences more accurately. For example, if the price of beef rises, the CPI does not account for consumers switching to chicken, but the PCE does

·         The weights assigned to different categories in the CPI are based on a fixed survey of consumer spending patterns. These weights are updated less frequently, which can lead to discrepancies over time as consumer behavior shifts.

·         The PCE updates its weights more regularly based on current expenditure data, reflecting more recent consumer spending habits. This results in a more dynamic representation of inflation as it adapts to changes in consumption patterns.

·         Historically, the Core CPI tends to report higher inflation rates compared to the Core PCE. For instance, since 2000, the average annual PCE inflation has been about 0.4% points lower than that of the CPI. This difference can be attributed to the broader scope and more adaptive nature of the PCE, which captures the effects of consumer substitution more effectively.

·         Both the Core CPI and Core PCE are essential for understanding inflation trends in the U.S. economy.

·         The Fed prefers Core PCE because it provides a more comprehensive view of inflation and better captures changes in consumer behavior.

Moreover, ahead of Nov’24 election, several US Senators/Congress members, both Democrats and Republican Presidential nominees (Harris and Trump) are not very happy about still elevated inflation compared to pre-COVID levels, still up by at least +20%, and insisting that Fed/Powell should focus on core CPI inflation rather than core PCE inflation, which is around 1.0-0.5% lower most of the times due to composition/weightage issue; ordinary people (vote bank) are worried about overall inflation (CPI), especially for daily essential goods & services, which is still significantly elevated than pre-COVID levels, while their real earnings may be still flat.

Powell also publicly acknowledged to a Senator in the last hearing/testimony (Mar’24) that US Congress officially mandated the Fed to maintain price stability mandate as +2% headline inflation (CPI), not PCE, which is always the lowest among various inflation gauzes. Powell pointed out that the Fed is now actually targeting core CPI inflation around +2.0%; say +/- 0.25% on a sustainable basis due to lower volatility, which is still higher than headline CPI due to the exclusion of volatile food & fuel/energy components. But as price stability, the Fed eventually tries to converge both core and total inflation to the same levels; i.e. both core CPI and total CPI around +2.3%,  and core PCE and total PCE inflation +1.5%.

Although the Fed generally targets +2.0% core PCE inflation as the price stability (inflation) target, in reality, it maintains that around +1.5%, which is equivalent to core CPI inflation targets around 2.0-2.3%. Before COVID, the Fed started cutting rates in late 2019 amid repo market disruptions (due to excessive QT) from Aug’19 (after Trump blasted out Powell), when 6MRA of core PCE inflation was around +1.6% and core CPI inflation was around +2.0%. Fed had cut rates from +2.50% to +1.75% in H2CY19 (pre-COVID).

The average rate of core disinflation was around -0.16% in 2023, which is now reduced by almost half to -0.08% in 2024. In 2023, the rapid pace of disinflation was due to the easing of the supply chain/constraints and also the supply of more workers/labor force amid huge immigration (legal/illegal). But the main effect of those easing in the supply chain (goods & labor/service) may be already over by 2023 (after withdrawal of all types of COVID restriction by late 2022) and thus we are now seeing comparatively slow, but predictable disinflation, although often stalled. Goods inflation is again ticking up amid higher demand from increasing population/immigration; also demand for housing, especially rented homes is high and also resulting in elevated rent/housing inflation.

On Thursday, the US Treasury Secretary Yellen said:

·         Ties with China have gotten closer, have found constructive ways to discuss differences

·         Inflation remains a top Biden administration priority but is down considerably, wages rising

·         It will be necessary to get deficits down to keep interest costs manageable

·         Overtime if we stay on that path, rates will decline to neutral

·         The last mile on inflation is housing

·         There appears to be an expectation among the Fed that rates will come down further

·         There's a little bit more slack now in the job market

·         Labor market and inflation suggest we're on a path to a soft landing

On Friday, Fed’s Kugler said:

·         The breakeven number for monthly job gains is anywhere from 100K to 240K

·         We do not want the labor market to weaken further

·         Maybe some Fed policymakers would be willing to move expected 2025 rate cuts forward to 2024 or vice versa, depending on the data

·         We need to continue normalizing rates

·         It will take a little time to get to 2% inflation

·         I don't see that we will overshoot on inflation

·         It makes sense to shift attention to the employment mandate

·         The job market has cooled, don't want it to weaken further

·         I strongly supported the 50 bps rate cut in Sep’24

·         The labor market has come into balance, helped by a rise in prime-age labor force participation as well as immigration

·         I expect spending to grow at a somewhat more moderate pace moving forward

·         Tight monetary policy has helped cool off demand, slow the economy, and keep inflation expectations in check

·         The Fed now must balance its focus to continue to make progress on disinflation while avoiding unnecessary pain, weakness in the economy

·         I will support additional rate cuts going forward if progress on inflation continues as I expect

·         I estimate personal consumption expenditures inflation at 2.2% in August, and core PCE at 2.7%, consistent with ongoing progress toward the 2% goal

·         The Fed should keep focus on reducing inflation and also shift attention to the maximum-employment mandate

·         It may take some time to feel prices are back to normal

·         There has been a significant moderation in the labor market recently, after a remarkable performance over the past four years

·         I strongly supported the US Central Bank's 50-basis-point interest rate cut

On Friday, Fed’s Musalem said:

·         We may cut faster if the job market weakens more than the forecast

·         I see more than one additional 25 bps cut for the rest of 2024

·         The Fed should lower interest rates gradually

On Friday, Fed’s Bowman reiterated:

·         Data points continue to show economic strength

Conclusions:

Thus Fed is now targeting to bring down average core inflation back to +2.0% on a sustainable basis keeping the average unemployment rate around 4.0% for its dual mandate. And if the US unemployment rate falls below 4.0% towards 3.5%, it would be a bonus for the Fed or a dream scenario. However, the Fed projected an elevated unemployment rate of around 4.4% by Dec’24 and Dec’25 amid a huge influx of immigrants in the US after COVID; the US labor force is now growing much more than US job openings or fresh job creation.

Although higher population growths, even by immigrants and not native Americans (declining birth rate) is causing higher demand, higher consumer spending, and higher GDP growths (than historical trends), it’s also causing high inflation as the supply capacity of the US economy is not increasing proportionately due to lack of adequate fiscal/infra stimulus and political/policy paralysis like situation for decades; US political/election system does not favor Trifecta/absolute majority for either Democrats or Republicans for more than two years. Even in exceptional situations. If one party gets a Trifecta (White House, House, and Senate) through the Presidential election, it may eventually lose it after the mid-term election only two years later.

Also, the US has now around $40T public debt if we consider both Federal ($35T) and state debts ($5T) and is paying more than 15% of core tax revenue as interest on such public debt and nominal GDP around $ 28 T. Thus US Congress, Treasury and also Fed has always an issue with such huge public debt and interest burden and fiscal policy.

Although is the global reserve and most trusted currency, USD is always in great demand globally from various countries and even terrorists! Thus despite almost 24/7 printing, USD has not tuned into a toilet paper, but the never-ending cycle of increasing public deficit, public debt, and currency devaluation (3D) is boosting Gold as an inflation hedge traditional asset in limited supply. Also, Gold is being boosted by safe-haven asset appeal amid lingering geopolitical tensions (Ukraine and Gaza war), especially in the last few years under the Biden admin (war-savvy Democrats!)

Looking ahead, the US needs to recalibrate its policy on immigration and fiscal/infra stimulus to balance the growing demand of the economy by growing supply capacity; otherwise, there may be higher inflation, higher unemployment and the Goldilocks nature of the US economy may be at risk, making Fed’s jobs more difficult. The present immigration flood into the US is being led by countries like India, Mexico, and also China to some extent.

Apart from any political narrative, even if we take the US economic data at face value despite abnormal revisions even after several months, the Fed has miscommunicated with the market; and also created confusion and asset bubbles by jawboning too much. Normally, the Fed never surprises the market as it has immense jawboning power and policy space. But this time, despite a very low FFR Swap probability of -50 bps cut, the Fed goes for the same, maybe after being confident not only about disinflation & reaching price stability target of +2.0% inflation, but also no Trump 2.0, Trumpflation, and Trump tantrum. Powell may not have to face Trump again in 2025.

Bottom line:

The projected Fed rate cut of -50 bps in Dec’24 not be assured as US core disinflation may have stalled in Q3CY24, while unemployment remains around 4.0%; Fed may cut -25 bps:

Overall, in Aug’24, the annual revision affected the PCE and core PCE index right from 2018; if there was no such revision, the sequential rate would be around 0.2 or 0.3%; in line with or even above sequential market expectations. Still, overall US core disinflation pace may have almost stalled in Q3CY24 and thus Fed may not cut rates back-to-back in Nov’24 meeting unless US unemployment rate for Sep’24 surges over 4.5% for any reason, And if US core disinflation pace does not accelerate in the coming months, then Fed may not also go for another 50 bps rate cut even in Dec’24 and cut only regular/normal -25 bps; Fed has to balance its dual mandate and thus has to dial back presently restrictive rate in a calibrated way ensuring soft landing.

Market Impact:

Wall Street Futures led by DJ-30 and also SPX-500 scaled a new life time high (LTH) on synchronized global easing on both sides of the Atlantic as well as Pacific (Fed-ECB-PBOC), but tech-heavy NQ-100 underperformed on growing tech war and regulatory restrictions about AI Chip between two superpowers of the world (US-China). On Friday, NQ-100 was dragged by Nvidia as China requested (instructed) local companies to avoid the usage of AI-grade chips Nvidia and use Made In China like that of Huawei.

On Friday, Wall Street Futures and gold also stumbled from session highs as fine details of the latest core PCE inflation data show the overall US core disinflation pace may have stalled in Q3CY24, which may prevent the Fed from any back-to-back rate cut of -25 bps in Nov’24 and even -50 bps cut in Dec’24; Fed may return to normal gradual rate cut strategy of -25 bps every alternate meeting/every QTR end.

Also growing conflict/war-like situation between Israel-Hezbollah/Lebanon and Putin’s nuclear war warning/narrative is undercutting stocks while boosting Gold, which is scaling fresh life time highs almost every other day. But Gold is also undercutting on hopes & hypes of an imminent Gaza/Lebanon war ceasefire, at least temporary till the US election amid intensifying efforts by the Biden admin.

On Friday, Wall Street was boosted by energy (China stimulus, higher oil), communication services, banks & financials, real estate, and industrials, while dragged by techs, materials (despite Chinese stimulus), consumer discretionary, healthcare and consumer staples. Scrip-wise, Wall Street was boosted by Chevron, Visa, United Health, Boeing, Amgen, American Express, Walt Disney, and Verizon, while dragged by Amazon, 3M, IBM, Microsoft, Walmart, and Intel.

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

Whatever the narrative, technically Dow Future (42500) has to sustain over 42700 for any further rally to 42900/43050-43250 and 43500/44000-44500/44800 in the coming days; otherwise sustaining below 42600/650, DJ-30 may again fall to 42400/42300-42100/42000 and 41800/41500-41200/41000* and further 40700/40300-40100/40000* and 39700/394350-39000*/38500 in the coming days.

Similarly, NQ-100 Future (20200) has to sustain over 20400 for a further rally to 20600/20700-20800/21050* and further to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 20350/300, NQ-100 may again fall to 20000/19750* and 19600/19350-19100/18900 and further 18750/18550-18400/18200-17950/17600 and 17450-17300/17000 in the coming days.

Technically, SPX-500 (5780), now has to sustain over 5850 for any further rally to 5900 and 6000/6050-6100/6150 in the coming days; otherwise, sustaining below 5825/800, may again fall to 5725-5675/5625-5600/5575*-5550/5500-5475/5450 and 5425/5390-5370/5300* and 5250/5100* and further 5050/4950*-4850/4750 in the coming days.

Also, technically Gold (XAU/USD: 2625) has to sustain over 2655 for a further rally to 2675*/2700-2725/2750 in the coming days; otherwise sustaining below 2650/2645, may again fall to 2625 and 2595/2590-2585/2575, may again fall to 2560*/2540-2530/2515 and 2495/2480-2470*/2425 and further 2415/2400-2390/2375 in the coming days (depending upon Fed rate cuts and Gaza/Ukraine war trajectory).