Gold and Dow soared on hopes of an early Fed rate cut by Mar’24

On Thursday, Wall Street closed mixed on hopes of a Fed pivot, and less dovish Fed talks, in line with expected core PCE inflation data and upbeat report card/update from Salesforce, Boeing and United Health. Dow surged, but the Nasdaq slipped as techs and communication/social media companies underperformed. Also, lingering uncertainty about the Gaza war extended/permanent ceasefire is undercutting Wall Street (US stocks), while boosting Gold, Silver and US bonds on safe-haven assets appeal amid elevated geopolitical tensions in the Middle East (Israel-Hamas Gaza war).

In the early Friday European session, Wall Street Futures slipped, while Gold got some boost after Israel's PMO confirmed the end of the extended Gaza war pause and the resumption of fighting with Hamas, which would be long and designed to eliminate Hamas and getting back hostages in the process. But the overall impact was small/brief as Israel and the U.S. are reportedly also planning to kill the top five Hamas leaders and force them to surrender or get out of Gaza-paving the way for a permanent ceasefire and sustainable/long-term peace (two states) solution. But softer than expected ISM manufacturing PMI and the confirmation of lingering manufacturing recession/slowdown in the S&P Global PMI survey also buoyed Wall Street Futures and Gold amid hopes of Fed pivot/early rate cuts in 2024.

On Friday, all focus of the market was on Fed Chair Powell in an event to see whether he/Fed is comfortable with the current market pricing for an early rate cut in May’24 after a series of dovish Fed jawboning, led by Waller. Although the market is now quite confident that the Fed’s current rate hike cycle is over, most of the Fed policymakers prefer a hawkish hold stance; i.e. maintaining the possibility of another +25 bps rate hike if it appears that core inflation is not cooling fast as expected. Also, most of the Fed policymakers are now not thinking about any rate cuts in early 2024 to ensure tighter financial conditions and lower inflation expectations.

But as the Fed is already talking about (discussing) rate cuts and core inflation is cooling quite fast, the market is now expecting -100 bps Fed rate cuts cumulatively in H2CY24; i.e. @ -25 bps each in July-September-November and December (if U.S. core CPI indeed averaged at around +3.0% in H1CY24). The present Fed repo rate is at +5.50%, while the average core CPI was around +5.40% in H1CY23 and expected +4.0% in H2CY23. Thus the real repo rate would be around +1.50% (5.50-4.00) by Dec’23.

Fed may hold the repo rate at +5.50% at least for H1CY24 and watch the actual core inflation trajectory for the 1st half of 2024 and the outlook thereof. If core CPI indeed falls below +3.0% and Fed is confident that average core CPI would be around +3.0% in H2CY24, then Fed may gradually cut rates by -1.00% for a repo rate at +4.50%, which will translate a real repo rate around +1.50% (4.50-3.00)- in line with present restrictive policy stance to bring core CPI back to below +2.00% by Dec’25.

On Friday, Fed’s Chair Powell said in an educational event (At a Fireside Chat at Spelman College, Atlanta, Georgia):

·         Fed will raise rates again if needed to lower inflation

·         FOMC moving forward carefully as risks of under- and over-tightening are becoming more balanced

·         It is premature to say monetary policy is restrictive enough

·         I expect spending and output to slow over the next year

·         For me, a big, big party---as good as it gets--- is a really good inflation report

·         The Fed has made considerable progress in lowering inflation

·         Fed Funds range well into restrictive territory

·         Uncertainty over economic outlook is unusually elevated

·         Inflation has eased but core inflation is still too high

·         We need to see more progress on lowering inflation to 2%

·         Wage growth is still high but moderating to a more sustainable level

·         I welcome the recent softening in inflation data

·         Fed actions have defended inflation-fighting credibility

·         Labor market conditions are very strong

·         The job market has cooled but is still strong

·         Unemployment is up but still historically low

·         FOMC is moving forward carefully as risks around rates become more balanced

·         Fed spends more time talking to Congress than before

·         US fiscal policy is unsustainable in the long run

·         I have been surprised by the upside this year with inflation coming down meaningfully but growth and jobs continuing

·         Inflation is still well above target but moving in the right direction

·         The data will tell the Fed if it has done enough or needs to do more

·         The Fed does not need to be in a rush now; we are getting what we wanted to get

·         There is a path to getting inflation down to 2% without large job loss, and we are on that path

·         Consumer spending has been surprisingly strong amid past fiscal stimulus/COVID grants and robust labor market (real wage growths)

·         Credit card use and defaults mean consumer spending may be slowing

·         We think GDP is slowing based on the limited data that we have

·         It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance or to speculate on when policy might ease

·         We are prepared to tighten policy further if it becomes appropriate to do so

Relevant text of Fed Chair Powell’s prepared opening remarks: At a Fireside Chat at Spelman College, Atlanta, Georgia: 1st December’2023

“Congress assigned the Fed the dual mandate goals of maximum employment and price stability. Both goals are essential aspects of a healthy economy. Congress also gave the Fed a precious grant of independence from direct political control to allow us to pursue those goals without consideration of political matters. Other major central banks in democratic societies have similar grants of independence, and this institutional arrangement has a strong track record of producing better policy outcomes for the benefit of the public.

To begin with our maximum employment goal, I am glad to say that, by many measures, conditions in the labor market are very strong. A couple of years ago, as the pandemic receded and the economy reopened, the number of job openings grew to greatly exceed the supply of people available to work, leaving a widespread shortage of workers. Today, labor market conditions remain very strong, and the economy is returning to a better balance between the demand for and supply of workers.

The pace at which the economy is creating new jobs remains strong and has been slowing toward a more sustainable level. That gradual slowing has come in part due to the efforts of the Fed to slow the growth of the economy to help reduce inflation. After declining sharply during the pandemic, the supply of workers has bounced back, as people have come back into the labor force and as immigration has returned to pre-pandemic levels.

Partly because of that labor force growth, the unemployment rate has edged up over the second half of the year, though it remains historically low at 3.9 percent. The increase in participation has been particularly strong among women in the prime working ages of 25 to 54, which surged to an all-time high earlier this year, and which remains well above pre-pandemic levels. Wage growth remains high but has been gradually moving toward levels that would be more consistent with 2 percent price inflation over time, and real wages are growing again as inflation declines.

As for price stability, the Federal Open Market Committee (FOMC) has a longer-run goal of 2 percent inflation. After running below 2 percent for over a decade, inflation increased sharply in 2021, in the United States and many other countries around the world. High inflation imposes a significant hardship on all households and is especially painful for those least able to meet the higher costs of essentials like food, housing, and transportation.

Beginning in early 2022, we reacted forcefully, raising our policy interest rate and decreasing the size of our balance sheet to help slow the economy and bring down inflation. Inflation has declined to 3 percent over the 12 months ending in October, but after factoring out energy and food prices, which tend to be volatile, what we call "core" inflation is still 3.5 percent, well above our 2 percent objective.

Over the six months ending in October, core inflation ran at an annual rate of 2.5 percent, and while the lower inflation readings of the past few months are welcome, that progress must continue if we are to reach our 2 percent objective. High inflation initially emerged from a collision between very strong demand and pandemic-constrained supply. The normalization of supply and demand conditions has played a critical role in the disinflation so far, as has the substantial tightening of monetary policy and overall financial conditions over the past two years.

The strong actions we have taken have moved our policy rate well into restrictive territory, meaning that tight monetary policy is putting downward pressure on economic activity and inflation. Monetary policy is thought to affect economic conditions with a lag, and the full effects of our tightening have likely not yet been felt. The forcefulness of our response to inflation also helped maintain the Fed's hard-won credibility, ensuring that the public's expectations of future inflation remain well-anchored. Having come so far so quickly, the FOMC is moving forward carefully, as the risks of under- and over-tightening are becoming more balanced.

As the demand- and supply-related effects of the pandemic continue to unwind, uncertainty about the outlook for the economy is unusually elevated. Like most forecasters, my colleagues and I anticipate that growth in spending and output will slow over the next year, as the effects of the pandemic and the reopening fade and as restrictive monetary policy weighs on aggregate demand.

The FOMC is strongly committed to bringing inflation down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective. It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so. We are making 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.”

Overall, Powell indicated current rate hike cycle is over unless there is a nasty surprise in the core inflation trajectory, but at the same time Powell also clearly said Fed is still uncertain that the current Fed rate is in a sufficiently restrictive zone to push core inflation back to +2.00% target over the medium term (by Dec’25); i.e. Powell deliberately kept the option of at least another hike in the coming months in line with most of other Fed policymakers to maintain the hawkish hold stance. Additionally, Powell also specifically said the present market speculation of an early rate cut is premature; i.e. Powell does not agree with the present market pricing of a Fed rate cut from as-early-as March-May’24.

Powell said clearly: “The FOMC is strongly committed to bringing inflation down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective. It would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance or to speculate on when policy might ease. We are prepared to tighten policy further if it becomes appropriate to do so.”

On Friday, Fed's Goolsbee said:

·         We are on track to 2% inflation

·         Inflation is coming down exactly as we want

·         The latest inflation data was absolutely what we wanted

·         Housing inflation is the highlight of what I’m watching - if it comes down to a pre-COVID level we would be on the path to 2% inflation

·         There is no evidence we've stalled at 3% inflation

·         Shocks are still possible, and past soft landings have been derailed by those

·         The labor market is very strong

·         We are doing great on the employment side of the Fed's mandate

·         If inflation is not on the path to 2%, and even if the unemployment rate is going up, we will not stop tightening

·         I am not nervous about a hypothetical tradeoff between employment and inflation

·         Fed's Goolsbee when asked what he sees as the biggest possible risk to the US economy in the coming year: A meltdown in China

·         There is a lot of inflation progress also from supply shocks

Conclusions:

If US core CPI indeed dips below +3.0% by May-June’24 and it seems that the 2024 average core inflation will be around +3.00%, then the Fed may start cutting rates from July’24 and may cut cumulatively -1.00% at -0.25% pace till Dec’24 for a repo rate at +4.50%, so that real rate continues to stand around +1.50%, in line with present restrictive stance.

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 9.5% 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 Fed is insolvent to the tune of -$30B. 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 falls 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.

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 ensuring US 10Y bond yield below 5.00-5.25%, 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 5.00-5.25% 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.

Market wrap:

On Friday, Wall Street Futures and gold soared, while USD slumped during Powell’s comments on hopes of an early Fed rate cut from March’24 instead of earlier May’24. This is despite Powell’s comments being less dovish than expected as Powell termed the current market pricing of an early rate cut from May’24 as speculative and premature. Subsequently, Gold soared to a fresh lifetime of around $2075, while DJ-30 surged +0.80%, NQ-100 gained around +0.5% and SPX-500 jumped almost +0.5%.

On Friday, Wall Street was boosted by real estate, industrials, consumer discretionary, utilities, materials, banks & financials, energy, consumer staples, healthcare, and techs, while undercut by communication services/social media companies. Dow Jones was boosted by Apple streaming JV with Paramount), Salesforce, Walgreens Boots, Nike, Caterpillar, J&J, and Goldman Sachs, while dragged by Intel, Microsoft, Walmart, United Health and P&G. Tesla also dragged NQ-100 after its Cybertruck was priced higher at $60.99K against previous guidance of around $40K (announced in 2019/pre-COVID).

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

Whatever may be the narrative, technically Dow Future (36316), now has to sustain over 36100 levels for a further rally of 37050-37350 in the coming days; on the other side, sustaining below 336050/36000 may further fall to 35350-35250, and may again fall to 35000-34800/34650-34120/34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (16024) now has to sustain over 16200 for a further rally to 16700-16800 zones; otherwise sustaining below 16150/100-16050, may again fall to around 15100-14140 in the coming days.

Technically Oil (75.60) now has to sustain over 79.50 for a further rally to 82.50/84.50-90.50/95.50; otherwise sustaining below 77.00-76.50/75.00, may again fall to 73.80/71.80-71.40/70.00 and even 66.40-65.40 in the coming days (if OPEC+ is unable to agree for a deeper cut and Saudi Arabia withdraws the voluntary cut).

Also, technically Gold (XAU/USD: 2072) now has to sustain over 2085 for any further rally to 2350 areas.; otherwise sustaining below 2080/2075-2060/2045, may again fall to 2020-2010/2005-2000/1995, and further to 1985/1975-1960/1950 and 1928/1908-1895/1885 and 1850/1810 in the coming days (if there was a permanent Gaza war ceasefire and Fed sounds more hawkish than being expected ON 13th December).