Fed talks signal a quarterly rate cut at 25 bps from Sep’24

·         Ahead of the blackout period, comments by Fed’s Waller, Williams, and others signal the start of the next rate cuts cycle from Sep’24 @25 bps for the next 11 QTRs

·         Unless a 6M or even a 3M rolling average of unemployment surges further above the 4.5% Fed red line from the present 4.0%, the Fed may not go for any jumbo (@50 bps) or consecutive rate cuts (@25 bps)

·         The present 6MRA of US core inflation is around 3.1%; the Fed has to bring it down to 2.0%, by ensuring the unemployment rate is below 4.0% (soft landing scenario)

·         The YTM-2024 core disinflation rate is -0.08% (from -0.16% in 2023), while the average R/R of unemployment is +0.06% (from +0.01% in 2023)

·         Fed may close the QT by Dec’24, which may reduce the present restrictive rate/stance more rather than rate cuts in combination with QT tapering

·         On early Monday, Dow Future recovered on Boeing's boost and short-covering

On Friday, Wall Street Futures and gold stumbled from a soft/mixed NFP high after Fed’s Williams, Waller, and even Goolsbee (known as dove) almost made it clear that the Fed will cut by -25 bps if Aug’24 core inflation data supports and as of now, there is no question about -50 bps jumbo cuts. Fed will keep cutting rates in an orderly way by -25 bps each quarter end for the next 10-11 QTRs to balance dual mandate of minimum price stability and minimum unemployment rate without causing a hard landing and preferably keeping the US economy in Goldilocks state (not too hot or too cold). Still, now there is no sign that the US economy or labor market is heading for a recession, requiring the Fed to go for jumbo/panic rate cuts to satisfy stimulus-addicted Wall Street.

The market was expecting almost -150/100 bps rate cuts by Dec’24, but the Fed may cut only -50 bps @-25 bps each in Sep & Dec’24. Subsequently, Gold stumbled from around 2530 to almost 2485. Earlier Gold scaled 2530 soon after US NFP/Job data from an initial knee-jerk low around 2507 on hopes & hypes of jumbo Fed rate cuts @-50 bps. Gold was also under pressure amid increasing public pressure on Israeli PM Netanyahu to finalize a ceasefire/hostage deal, while also buoyed by the increasing war of drones & missiles between Russia & Ukraine (even deep into Russia). The market is concerned about any miscalculation by Russia or the US/Ukraine, leading to mini WW-III.

On Friday, Dow Future initially jumped to around 41095 from 40630 soon after the mixed US NFP job report on hopes & hypes of -50 bps rate cuts in Sep & Dec’24. But Dow Future soon stumbled to almost 40245 on fading hopes of jumbo Fed rate cuts along with the lingering concern of a hard landing. Additionally, Wall Street was also under pressure led by techs amid fading optimism over AI/Chat GPT as some GS reports indicate comparatively lower web footprints in the last few weeks!

On Friday, soon after the US NFP/BLS job report for Aug’24, Fed’s Governor Waller said in a prepared speech:

The Time Has Come

“My topic is the outlook for the U.S. economy and the implications for monetary policy, a set of judgments that have, of course, been influenced by this morning's jobs report. When I scheduled this speech several months ago, I knew it might be challenging to speak a few hours after the release of such an important piece of data. But we like to say that monetary policy must be nimble, so that means policymakers must be nimble also. Not Simone Biles nimble, but nimble. As you will hear, I believe the data we have received this week reinforces the view that there has been continued moderation in the labor market. In light of the considerable and ongoing progress toward the Federal Open Market Committee's 2 percent inflation goal, I believe that the balance of risks has shifted toward the employment side of our dual mandate and that monetary policy needs to adjust accordingly.

Looking back at the economic data over the first six months of 2024, it portrayed an economy slowly cooling and not showing signs of significant weakening. The labor market had been gradually moderating for the past year or so, and although inflation rose in the first quarter, it then retreated in the second, and there was a widespread view heading into the second half of the year that the FOMC was on track to achieve a much desired but unusual "soft landing."

Then the July jobs report came in unexpectedly soft. Job creation slowed and the unemployment rate increased by two-tenths of a percentage point to 4.3 percent, the highest since October 2021. There was speculation that weather-related issues might have distorted these results and the unemployment rate ticked down in this morning's release. But, overall, the August report along with other recent labor data tends to confirm that there has been a continued moderation in the labor market.

The ups and downs in the data over time highlight what I consider the right approach to meeting the FOMC's dual mandate goals—I believe we should be data-dependent, but not overreact to any data point, including the latest data. When we faced a period of banking instability in the spring of 2023, there were calls from some to stop rate hikes despite inflation still running over 5 percent. But there were other tools in hand to deal with that stress, monetary policy did not overreact, and the FOMC continued tightening policy.

When inflation fell unexpectedly in the second half of last year, we did not overreact and immediately cut the policy rate. Then when inflation accelerated in the first quarter, we did not overreact and raise rates despite some calls to do so. I will be looking at these last two employment reports in combination with all other data as we head into the September FOMC meeting to decide the best stance of policy. I believe our patience over the past 18 months has served us well. But the current batch of data no longer requires patience, it requires action.

Today's jobs report continues the longer-term pattern of a softening of the labor market that is consistent with moderate growth in economic activity, the details of which I will get into in a moment. As I said at the outset, considering the progress we have made on getting inflation back to target, I believe that the balance of risks is now weighted more toward downside risks to the FOMC's maximum-employment mandate.

While the labor market has cooled, based on the evidence I see, I do not believe the economy is in a recession or necessarily headed for one soon. The collective set of economic data indicates to me that the labor market and the economy are performing solidly and the prospects for continued growth and job creation are good, with inflation near 2 percent. I continue to believe that this can occur without substantial harm to the labor market. But I also believe that maintaining the economy's forward momentum means that, as Chair Powell said recently, the time has come to begin reducing the target range for the federal funds rate.

In the rest of my remarks, I will lay out my reasons for believing that the economy and employment will likely keep growing as inflation moves toward 2 percent. The first of these is the large body of evidence that economic activity is continuing to grow at a solid pace. Real gross domestic product (GDP) grew at a 2.2 percent annual rate in the first half of this year and recent data indicates that growth is continuing at around this pace in the third quarter.

Retail sales were stronger than expected in July and showed that households continue to spend as their finances, in the aggregate, remain healthy. The increase was fairly broad based on goods categories. While many online retailers offered discounts last month, this was not a dominant factor in the solid results. Although manufacturing output fell in July and the August Institute for Supply Management manufacturing survey pointed to weak production and new orders, the similar survey for the larger, nonmanufacturing sector was consistent with a modest expansion of activity.

As for the labor market, on balance, the data that we have received in the past three days indicates to me that the labor market is continuing to soften but not deteriorate, and this judgment is important to our upcoming decision on monetary policy. As I said earlier, Wednesday's report on job openings in July was consistent with a moderating labor market. Meanwhile, the four-week moving average of initial claims for unemployment insurance has risen gradually since January but has changed little on the net in the past two months, with initial claims remaining fairly low.

The jobs report for August, released this morning, supported the story of ongoing moderation in the labor market. After rising to 4.3 percent in July, the unemployment rate ticked down to 4.2 percent in August. Taking a longer perspective, the unemployment rate over the past 16 months has increased gradually but fairly steadily from 3.4 percent to 4.2 percent in today's release.

Payrolls rose by 142,000 in August compared with 89,000 in July, leaving the three-month average payroll gain at 116,000, compared with the 267,000 average in the first quarter and 147,000 in the second. Accounting for revisions to the jobs numbers that we received in August, that level is a bit below what I see as the breakeven pace for job creation that absorbs new entrants to the workforce and keeps the unemployment rate constant.

July marked the first time that the three-month average unemployment rate has increased by at least half of a percentage point above its 12-month low, which was 3.6 percent in July 2023. This breached a threshold established by the Sahm rule, which observes that when this has occurred in the past, it has been a reliable indicator of the economy entering a recession.

While this is a correlation that certainly bears attention, I want to make a few cautionary points about relying on such rules in deciding that a recession has begun. As we have seen in the recent past with other supposedly reliable recession rules, such as an inverted yield curve, there is more to forecasting economic outcomes than the relationships between a couple of variables.

First, these rules are nothing more than a mechanical, statistical description of past economic outcomes—they do not seek to explain what economic forces drive the relationship between the data, nor are they based on the totality of economic data. All recession rules do is pick up a correlation between movements in economic data and the dates of recessions or other outcomes. A second point is that setting aside the unusual circumstances of the 1981–82 recession, recessions occur when a major shock hits the economy. In the absence of a big negative shock, an inversion of the yield curve or triggering of the Sahm rule doesn't necessarily mean we are entering a recession.

Third, recession rules typically pick up demand-driven recessions. But this is not why unemployment is rising now. GDP forecasts for the current quarter all show solid growth, labor market data show layoff rates are stable, and consumer spending is growing at a healthy rate. These data suggest demand is fairly strong. Instead, most of the increase in the unemployment rate is from workers entering the labor force and not finding jobs right away. So, the recent rise in the unemployment rate appears to be more of a supply-side-driven phenomenon, not demand-driven.

And lastly, it should be clear to everyone that many pre-pandemic economic relationships have not proven to be good policy guides post-pandemic. Reliance on old lessons from inverted yield curves to predict a recession, a Phillips curve to predict inflation, or a flat Beveridge curve to predict the movement in the unemployment rate has all led to mistaken economic forecasts.

While I don't see the recent data pointing to a recession, I do see some downside risks to employment that I will be watching closely. But at this point, I believe there is substantial evidence that the economy retains the strength and momentum to keep growing, supported by an appropriate loosening of monetary policy.

Let me now turn to the outlook for inflation. With the labor market cooling, it doesn't surprise me that wage growth has slowed to a pace consistent with the FOMC's price-stability goal, and this is supporting ongoing progress toward that objective. The employment cost index grew at an annualized rate of 3.5 percent from March to June, and the 12-month change was 3.9 percent for private sector workers, the lowest since late 2021. Average hourly earnings, reported in today's jobs report, rose at a three-month annualized pace of 3.8 percent in August, the same as the 12-month change.

Inflation in July continued to show progress toward the FOMC's goal. The price index for personal consumption expenditures (PCE), the Committee's preferred inflation measure, increased at a monthly pace of 0.2 percent in July for both total and core PCE inflation. Core PCE inflation, which excludes volatile food and energy prices, is a good guide to underlying inflation, and it increased 2.7 percent over the past 12 months. Given the downward trajectory of monthly readings, I also look at the 6- and 3-month annualized rate. These stand at 2.6 percent and 1.7 percent, respectively. These numbers are good news and suggest that our restrictive policy stance has put us on the right path to attain our 2 percent inflation target.

Looking across the components of inflation, one can see the breadth of the disinflation. Over 50 percent of categories in the total and core market baskets had annualized monthly inflation less than 2.5 percent in August. The index of core goods prices has reverted to its historical pattern of slight deflation, reflecting normalized supply after the disruptions of the pandemic as well as ongoing technological and productivity advances. Meanwhile, services price inflation has slowed as wage growth has slowed, since labor is a large input for much of the service sector. Overall, I see significant and ongoing progress toward the FOMC's inflation goal that I expect will continue over the remainder of this year.

Now let me discuss the implications of this outlook for monetary policy. As I said at the outset, considering the achieved and continuing progress on inflation and moderation in the labor market, I believe the time has come to lower the target range for the federal funds rate at our upcoming meeting. Reducing the policy rate now is consistent with many versions of the Taylor rule, which suggests reducing the policy rate is appropriate given the data in hand.

Furthermore, I do not expect this first cut to be the last. With inflation and employment near our longer-run goals and the labor market moderating, a series of reductions will likely be appropriate. I believe there is sufficient room to cut the policy rate and remain somewhat restrictive to ensure inflation continues on the path to our 2 percent target.

Determining the appropriate pace at which to reduce policy restrictiveness will be challenging. Choosing a slower pace of rate cuts gives us time to gradually assess whether the neutral rate has in fact risen; but at the risk of moving too slowly and putting the labor market at risk. Cutting the policy rate at a faster pace means a greater likelihood of achieving a soft landing but at the risk of overshooting on rate cuts if the neutral rate has risen above its pre-pandemic level. This would cause an undesired loosening of monetary policy.

Determining the pace of rate cuts and ultimately the total reduction in the policy rate are decisions that lie in the future. As of today, I believe it is important to start the rate-cutting process at our next meeting. If subsequent data shows a significant deterioration in the labor market; the FOMC can act quickly and forcefully to adjust monetary policy. I am open-minded about the size and pace of cuts, which will be based on what the data tell us about the evolution of the economy, and not on any pre-conceived notion of how and when the Committee should act.

If the data supports cuts at consecutive meetings, then I believe it will be appropriate to cut at consecutive meetings. If the data suggests the need for larger cuts, then I will support that as well. I was a big advocate of front-loading rate hikes when inflation accelerated in 2022, and I will be an advocate of front-loading rate cuts if that is appropriate. Those decisions will be determined by new data and how it adds to the totality of the data and shapes my understanding of economic conditions. While I expect that these cuts will be done carefully as the economy and employment continue to grow, in the context of stable inflation, I stand ready to act promptly to support the economy as needed.”

Notes by Fed Governor Waller:

·         The preliminary estimate of the annual benchmark revision to the establishment survey data, which was announced on August 21, suggests that payroll growth between April 2023 and March 2024 will likely be revised down early next year by about 68,000 per month on average. The implications for payroll growth beyond March are less clear

·         The 1981–82 recession was triggered by tight monetary policy to fight mounting inflation

·         The employment cost index is a valuable measure of compensation growth because it covers non-wage benefits and accounts for shifts in the shares of workers in different occupations and industries

Fed watches ECI (Employment Cost Index-Regular Salary + Other Benefits) data closely for wage inflation factor. In Q2CY24, the ECI grew at an annualized rate of +3.6%, easing from the Q1 rate of +4.8%, while ECI for the private sector eased to +3.9%, at its lowest since late 2021, but still substantially above the +2.7% in Dec’19 (Pre-COVID).

Conclusions:

Fed may launch the next rate cut cycle by cutting rates from Sep’24 @25 bps and continue the same every quarter end for the next 10-11 quarters unless the unemployment rate surprisingly surged above 4.5% or core inflation again picked up. If the unemployment rate surprisingly surges, then the Fed may consider cutting rates in consecutive FOMC meetings by -25 bps cuts or even some jumbo rate cuts (@-50 bps). Fed always and will continue to consider 6MRA or even 3MRA of total data (mainly core inflation and unemployment rate) for any policy stance rather than 1-2 months of data. The 6MRA of the US unemployment rate was at 4.0% in Aug’24 and unless it surges further above 4.5% in the next few months, the Fed may not indulge in panic-driven jumbo (-50 bps) or even consecutive rate cuts (-25 bps).

Till July’24, the 6MRA of US core inflation (CPI+PCE) was around +3.1% against a target of +2.0%, while till Aug’24, the unemployment rate was 4.0% against a target of 3.5% (maximum employment-unemployment rate: ~3.6%). Looking ahead, if US core CPI data for Aug’24 does not surprise on the upside, the Fed may start the eleven QTRs rate cut cycle from Sep’24 by cutting -25 bps each QTR end for in H2CY24, CY25, CY26 and Q1CY27. The Fed may cut -275 bps cumulatively from Sep’24 to Mar 27/June’27 for a terminal/neutral repo rate of +2.75% against average core inflation +2.0% on a durable basis.

The market is already discounted almost fully after the Fed dot-plots in March and June’24. Looking ahead, the Fed may change the Sep’24 dot plots to reflect 50 bps rate cuts in 2024, 100 bps each in 2025-26, and 25/50 bps in 2027 (if the Fed wants to keep a longer-term neutral rate at +2.75% or +2.50%). Ahead of the Nov’24 US election, we may see a falling unemployment rate below 4.0% and stable core inflation data, which may keep both the Fed and the White House in a good mood without irritating Trump. If Powell now cuts -50 bps against normal -25 bps without any sign of recession/financial crisis, the Fed/Powell has to also face Trump rhetorics as we have seen during Trump 1.0.

Market Impact:

On early Monday, Dow Future recovered on short covering and value buying coupled with Boeing boost after some settlement with Labor union, potentially avoiding a crippling strike.

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

Whatever the narrative, technically Dow Future (40970) has to sustain over 41300-41500 for any further rally to 41650/41750*-41950/42100* and 42700/41900-43050/44250-44500/44800 in the coming days; otherwise sustaining below 41200-41000, DJ-30 may again fall to 41900/40700-40500*/40300 and 40150/40000*-39700/39450 and further 39350/39200-39100/38900 and 38500*/38300-38000/37600 in the coming days.

Similarly, NQ-100 Future (18650) has to sustain over 18900/19000-19200/19500 for further recovery and rally to 19800/20050-20200/20300 for any further rally to 20400*/20600-20800/21050* and further to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 18750-18650, NQ-100 may again fall to 18400/18200-17950/17600 and 17450-17300/17000 in the coming days.

Technically, SPX-500 (5475), now has to sustain over 5550 for any further rally to 5575/5675 and 5725/5750*-5850*/5900 and 6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5550-5500 may again fall to 5450/5390-5370/5300* and 5250/5100* and further 5050/4950*-4850/4750 and 4550/4450-4350*/3850 in the coming days.

Also, technically Gold (XAU/USD: 2500) has to sustain over 2510 for a further rally to 2520/2530-2540* and 2560*/2575-2600/2650 in the coming days; otherwise sustaining below 2505, may fall to 2490/2480-2460/2445* and 2435/2420-2410/2400 and further to 2375/2350*-2325/2300 in the coming days.