Dow under stress on fading hopes of an imminent Fed rate cuts

On Wednesday, Wall Street Futures and gold soared on hopes & hypes of an early Fed pivot/put. The market was expecting -100 bps Fed rate cuts in 2024 and 2025 each (from June 24) and QT tapering from June’24 to close the same by Dec’24. But going by the overall Fed/Powell statements, Q&A comments, trend of core inflation, and also the Nov’24 US Presidential Election, the Fed may go for -75 bps rate cuts in 2024 starting from September after closing the QT by Aug’24. Previously, the market was anticipating Fed rate cuts from June’24.

Subsequently, Gold stumbled from around 2222 post-Fed early Thursday to almost 2157 Friday, while Wall Street Futures also slid. Dow Future stumbled from around 40316 to 39824; and NQ-100 from around 18707 to 18490. Wall Street was boosted by AI chip makers led by NVIDIA, FedEx (guidance update amid various cost-cutting measures), JPM, Boeing, Caterpillar and Lockheed Martin while dragged by Tesla, (lower production figure in China) and Nike.

The market is also concerned about ‘normalization’ by BOJ; if BOJ indeed starts hiking both repo and reverse repo rates, when the Fed is cutting rates, it will cause higher JGB bond yields and some disruption in global bond yields may be also seen. BOJ may start hiking rates in Q4CY24 in response to Fed rate cuts.

On Friday (22nd March), BOJ Governor Ueda said:

·         BOJ's massive stimulus deployed by former governor Kuroda helped to arrest sharp yen rises at the time, created jobs, and improved corporate profits

·         Our latest decision is based on the understanding that we will leave it to the markets to determine long-term rate moves

·         We would like to eventually decrease our JGB buying, but for the time being, we will take a wait-and-see stance

·         As seen in the rise in the overnight call rate, our decision this week was an interest rate hike

·         BOJ's JGB holdings will remain at current levels for the time being

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

·         I see few real challenges to the dollar as the reserve currency

·         Biden's proposed 5% minimum tax on Americans with $100 mln in wealth would cover unrealized capital gains

On Monday's early European session, risk trade also got some boost after China's Industry Minister announced some plans to promote digital transformation and accelerate the adoption of new information technology in manufacturing and industrial chains, as well as support the construction of smart factories. China's Finance Minister also allocates more fiscal resources (fiscal stimulus) to ensure employment; and prioritizes support for scientific and technological innovation and development in manufacturing. China's Finance Minister also expresses confidence in achieving full-year economic development goals.

Also, China's Premier Li announces:

·         Firmly holding the bottom line of preventing system risks, pushing for long-term and healthy development of China's economy

·         Pledges improved coordination for risk management and high-quality development

·         Measures taken to defuse property and debt risks have proven effective

·         Steadfastly promotes transitioning of industrial, energy, and transportation structures

·         To Ramp Up Developing New Productive Forces and Actively Develop Emerging Industries Like Biological Manufacturing

·         Will advocate for the innovative development of the data economy and increase the development of artificial intelligence

·         All domestic and foreign businesses will receive equal treatment under policies aimed at boosting domestic demand

·         Aims to increase domestic demand

·         Ultra-long special treasury bonds worth 1 trillion yuan (around $700B) will effectively stimulate investment and stabilize economic growth

·         There is low inflation, low central government debt ratio, and ample room for macro policy

·         There will be soon some regulations on market access, supply, and demand matching, and cross-border data flows after careful study of the issues

·         Economy's Long-Term Trend for the Better Won't Change Despite Fluctuations

·         Economic development is off to a good start in the first two months

·         China's economic rebound consolidates and strengthens

But Wall Street Futures were also undercut after an FT report that China blocks the use of Intel & AMD chips in government computers along with reservation on Windows OS!

On late Friday/Monday, Fed’s Bostic said:

·         We now project just one interest-rate cut this year, adding that reduction will likely happen later in the year than he previously expected

·         Notes businesses see signs of slowing, but not distress; also no signs of imminent layoffs

·         The Fed is aware of CRE risks but doesn't see them as broad-based

·         I want to avoid volatility from the balance-sheet runoff

On Monday, Fed’s Goolsbee said:

·         I expect three rate cuts this year

·         Asked if June is on the table, said everything is on the table but depends on data; We are in historic

·         Three cuts in 2024 were in line with my thinking

·         The main puzzle with inflation is housing

·         We need to see progress in inflation coming down

·         Cutting rates too soon could be more disruptive

·         The Fed has to strike a balance with its dual mandate

·         It doesn't feel like the story fundamentally changed.

·         We're in a bit of a murky period with inflation

On Monday, Fed’s Cook said:

·         Not sure if the neutral rate is higher or not, we will likely only know after the fact

·         The path of disinflation has been bumpy and uneven, as expected

·         It could be that some services prices still adjusting to increases in pandemic-era input costs

·         Comprehensive measures of wage growth show a gradual cooling

·         Artificial intelligence is a potentially significant source of productivity growth, but that will take time

·         Inflation has fallen considerably and the labor market has remained strong

·         The wage growth differential between job switchers, those staying in jobs has narrowed

·         The current low rate of increase on new rental leases suggests housing services inflation will continue to fall

·         The path of disinflation, as expected, has been bumpy and uneven

·         A careful approach to easing policy over time can ensure inflation returns sustainably to 2% while striving to maintain a strong labor market

·         Strong productivity growth could mean a faster pace of wage growth not inflationary

·         Risks to achieving the Fed's employment and inflation goals moving into better balance

·         There are risks to easing policy too much or too soon as well as too late

Conclusions:

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.6%. Fed may cut 75-100 bps in H2CY24 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)

=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

Fed may announce a plan for QT tapering/closing in the May meeting and should close the same before going for rate cuts in H2CY24. Fed, the world’s most important central bank may not continue QT (even at a reduced pace) and go for rate cuts at the same time as QT, and rate cuts are contradictory, although Fed/Powell kept the option open, at least theoretically.

Fed’s B/S size is now around $7.54T (as of 13th Mar’24), reduced from around $8.96T life time high scaled in Apr’22. Looking ahead, the Fed may maintain its B/S size around $7.00T, which would be 25% of the projected CY24 nominal US GDP of around $28T. Fed had indicated previously (before COVID) that B/S size is around 20% of nominal GDP.  In Sep’2019, QT tapering (started in 2017) caused B/S size to fall to around $3.77T from around $4.47T, which caused severe disruption in the US money/funding market, forcing the Fed to go for small QE even before COVID.

Now Fed’s QT rate is $95B/M; i.e. $0.095T/M; if Fed intends to keep its B/S size around $7.00T from the existing $7.54T, it needs around 5-6 more months at the same rate of $0.095T/M; i.e. by Aug’24, Fed may be able to reduce its B/S size to around $7.00T and stop the QT. In that scenario, the Fed may go for -75 bps rate cuts in September, November, and December’24. By 18th September (Fed MPC date), the Fed will have complete data for core inflation and also unemployment/real GDP data till Aug/July’24 to have the required ‘higher confidence’ to go for rate cuts.

After the 2019 money/funding market crisis/disruptions caused by QT, the Fed introduced the ON RP/RRP lending facility (Overnight Repo and Reverse Repo Repurchase Agreement) to ensure financial stability even during QT periods, which generally causes less intention among big banks/MMFs (money market funds) to lend each other. Thus, this time QT was not disruptive like we saw in late 2019 causing some slide in Wall Street and making Trump furious against Fed/Powell.

Looking ahead, Fed may keep B/S size around $7.00T, at mid-2020 levels during COVID times to ensure financial/Wall Street stability along with Main Street stability (price stability and employment stability).

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 incumbency wave (dissatisfaction) among general voters against Biden admin (Democrats).

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 hike 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 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 4.50-5.00% at any cost.

Bottom line:

Fed may not continue QT (even at a lower pace) and go for a rate cut cycle at the same time as these two policy actions are contradictory. Thus Fed may opt to first close the QT by Aug’24 at a B/S size of around $7.00T from the present $7.54T through the present pace of $0.095T/M. Then 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%. Fed is now using ON RR/RRP for funding market stability, especially for smaller/regional US banks (around 10% of the US banking system), there is no visible effect of QT unlike during late 2019. Thus Fed may opt for direct QT closing at the present pace by Aug’24, keeping the B/S size around $7.00T, almost 25% of the estimated nominal GDP ($30T) by 2024.

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

Whatever may be the narrative, technically Dow Future (39706), now has to sustain over 40700 levels for any further rally to 42600  levels in the coming days; otherwise, sustaining below 40650-40450 may again fall to 39250/38700-38200/37950 levels in the coming days.

Similarly, NQ-100 Future (18526) now has to sustain over 18850 levels for any rebound towards 19000/19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18800-18700, NQ-100 may gain fall to around 18000/17500-17200/16875 in the coming days.

Also, technically Gold (XAU/USD: 2172) now has to sustain over 2195 for any further rally to 2225/2250-2275/2300; otherwise sustaining below 2190-2145*, may again fall to 2120/2110-2100/2080-2060/2039 and 2020/2010-2000-1995/1985-1975 and even 1940 may be on the card (if Fed indeed goes for direct  QT closing without tapering and delays rate cuts to Sep’24, while a permanent Gaza war ceasefire takes concrete shape).