Gold and Dow surged on dovish talks by Fed’s Waller

On Monday, Wall Street Futures were undercut by the lingering uncertainty about a permanent Gaza war ceasefire but also buoyed by lower bond yields after an upbeat bond auction (showing resilient demand for U.S. debts) and softer-than-expected U.S. home sales. Gold surged to almost 2018 from Friday’s closing levels around 2005 on Gaza war suspense and lower USD/US bond yield. Gold was also boosted by reports of growing Chinese demand. Similarly, Silver also jumped to a multi-month high amid higher industrial/EV/telecom/5G demand and lower supply due to lower output from key producing countries (Mexico and Peru).

On early Tuesday, Wall Street Futures were almost flat, while Gold was also rangebound between 2018 and 2011 on an extended unofficial Gaza war pause for two more days (as Israel didn’t announce the extended pause officially). Overall, the market is now expecting an extended Gaza war pause followed by a permanent ceasefire and a feasible/sustainable peace/two-state solution to end this legacy problem forever. It now also seems that Hamas has almost broken and is ready to surrender with a face-saving strategy/formula after months of extensive Israeli military operations, costing over 22K civilian lives with the complete/80% destruction of Northern Gaza; Israeli also lost around 1700 civilian lives due to the horrendous act of terrorism by Hamas on 7th October.

However, Israel is now under immense global pressure including U.S. and Europe to declare a Gaza war permanent ceasefire and continue to carry out targeted surgical strikes to eliminate top Hamas leadership (instead of an all-out war against innocent civilians, women and children), due to domestic political compulsion, Israel war cabinet/PM is unable to declare a permanent Gaza war ceasefire. Thus U.S. Secretary of State Blinken is traveling to Israel, the occupied West Bank and the UAE/Qatar this week to discuss and press for more humanitarian aid to Gaza, the release of more Hamas captives and work to improve protections for civilians in the Strip.

Blinken will also discuss the future of Gaza and the need for an independent Palestinian state with ‘regional partners’. Biden admin is trying to convince the Israeli government to end the Gaza war and push for a long-lasting solution (separate Palestine state). On Monday, EU foreign policy chief Borrell also said there will be no peace or security for Israel without the establishment of a Palestinian state; but EU/Europe is also divided over the two-state solution for Palestine.

The U.S. CIA and Israeli spy Mossad chief are also meeting with Hamas officials through Qatar/Egypt mediation for a workable ceasefire solution. As per some reports, Israel may be now preparing to launch a military operation in Southern Gaza as Hamas may have a command and control center there, which was earlier regarded as a ‘safe zone’.

As per various reports, Hamas was initially a byproduct of IDF/U.S. patronage to counter the growing influence of PLO (Arafat). Now Hamas has turned into a ‘Frankenstein’ and is a rich terrorist organization being funded by various illegal ways including extortion, protection money, legal/illegal business such as real estate through various fronts, money laundering, drug trafficking etc. Hamas also get huge fund from foreign sources as donation, and grants, while various Arab/Muslim countries including Iran, Qatar, Egypt and Saudi Arabia also provide huge funds.

As per reports, top Hamas leadership are billionaires, while around 1200 top/mid-Hamas officials are millionaires, having lavish lifestyles. On the other side, most of the ordinary Palestine people are poor and suffering hugely from these legacy issues including the present Gaza war. Thus there is a need for political will by all concerned parties to convince Hamas and Israel's leadership for a permanent peace solution with surrender of Hamas arms & ammunitions. In return, Qatar, Egypt, Saudi Arabia, and Iran should take responsibility for Hamas/Gaza security and no terrorist attack on Israel by Hamas in the future to stop this never-ending cycle of violence and bloodshed.

Israel also can’t expect permanent peace by destroying civilian houses/hospitals/other infra and killing innocent civilians including children and women (equivalent to genocide). Palestine also should be rebuilt as a civilized separate country with its own civil and military admin and not be allowed as a haven for terrorist activities. Over the years, Hamas has turned terrorism into a lucrative business, while producer nations/companies of military equipment (US, Russia, China, Israel, Germany, UK and Iran) are also enjoying blockbuster revenue from terrorist organizations such as Hamas.

On Tuesday, Fed’s Waller said:

·         There are good economic arguments that if inflation continues falling for several more months, you could lower the policy rate

·         If inflation consistently declines, there is no reason to insist that rates remain high

·         I am increasingly confident that policy is well-positioned to slow the economy and get inflation back to 2%

·         I see fourth quarter GDP at perhaps 1% to 2%, The last couple weeks of data make Q3 appear to be a one-off jump in growth

·         Slowing of the economy will have an impact on credit delinquencies, and earnings; those are signs of moderating demand as the Fed intends

·         There will be a repricing of commercial real estate, but it will be well anticipated and not a shock

·         Absent a shock, there is no reason the Fed cannot pull off a soft landing

·         There could still be a shock that throws a soft landing off course, but that cannot be forecast

·         The increasingly confident policy is well-positioned to slow the economy

·         We need some improvement in services inflation ex-housing for overall inflation to reach 2%

·         I cannot say for sure if the Fed has done enough; data over the next couple of months will hopefully tell

·         The recent loosening of financial conditions is a reminder to be careful about relying on market tightening to do the Fed's job

·         I am encouraged by signs of moderating economic growth

·         Inflation is still too high, and it is too early to say if slowing will be sustained

·         Supply-side problems are mostly behind us, monetary policy will need to do the work from here

·         It is premature to rely on productivity growth gains to guide the stance of Fed policy

·         Consumer spending is cooling, manufacturing and non-manufacturing activity has slowed

·         The labor market is cooling off, but is still fairly tight, I will watch it closely

·         For inflation to continue falling to our 2% target, the economy needed to slow from its torrid third-quarter pace. If it did not cool off, then it was likely that progress on inflation would stop or even reverse. So, what remained to be seen was whether the economy would cool or inflation would heat up

·         While I am encouraged by the early signs of moderating economic activity in the fourth quarter based on the data in hand, inflation is still too high, and it is too early to say whether the slowing we are seeing will be sustained

·         But I am increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2 percent

·         That said, there is still significant uncertainty about the pace of future activity, so I cannot say for sure whether the FOMC has done enough to achieve price stability

·         Hopefully, the data we receive over the next couple of months will help answer that question

·         The initial estimate was that real gross domestic product (GDP) grew at a vigorous 4.9 percent pace in the third quarter. We'll find out tomorrow if that estimate holds up, but growth in the quarter picked up from the first half of 2023 when real GDP grew at a little more than a 2 percent pace

·         Growth in consumer spending, which accounts for most of GDP, was strong in the third quarter

·         Data on economic activity in October indicate that consumer spending is cooling from its pace in the third quarter

·         Retail sales fell 0.1 percent, the first drop since March. Spending was down on motor vehicles, an interest-sensitive sector, which may be evidence that that the FOMC's tightening of monetary policy is having some effect

·         Spending was also down at gasoline stations, mostly because of a sizable decline in gas prices, often a larger factor for this segment of retail than shifts in demand

·         But even without motor vehicles and sales at gas stations, retail sales barely increased in October, which may reflect a broad-based moderation in demand

·         All in all, it seems like output growth is moderating as I had hoped it would, supporting continued progress on inflation

·         The bottom line here is that the labor market is still fairly tight and I will be watching closely to see whether it continues to moderate in ways that keep inflation moving toward 2 percent

·         Core inflation excluding food and energy was still a modest 0.2 percent sequentially

·         Core CPI inflation was 4 percent over the past 12 months, but a better sense of the recent trend comes from the annualized rate of 3-month inflation, which for the core was 3.4 percent in October

“The question is whether inflation can continue to make progress toward 2 percent. There are some factors favoring this outcome, so let me walk through them.

First, housing services inflation, based heavily on rents, has slowed from its peak last year, and the lagged effect of moderation in rental prices in the past year should keep this sizable component of inflation at a moderate level. Goods prices have contributed a lot to the decline in inflation recently and have moderated so much that they probably won't be contributing much more. But a service excluding housing, which accounts for about half of PCE inflation, has not moderated as much as other categories, and there will have to be some improvement there for overall inflation to reach 2 percent.

Labor costs are a significant share of these service price increases, and the moderation in wage growth I mentioned earlier should help lower this segment of inflation. The increase in average hourly earnings has slowed to an annualized rate of 3.2 percent over the past three months, below the 4.1 percent 12-month rate, a sign of continuing improvement. That is also the indication from the Atlanta Fed's Wage Growth Tracker, which uses household survey data to estimate annual wage increases. It was as high as 6.4 percent in March and was down to 5.2 percent in October.

A broader measure of compensation, the quarterly employment cost index, has improved less dramatically this year. A services-oriented measure of wage increases constructed by the St. Louis Fed also showed slowing. This research, based on data from the payroll company Homebase, shows wage pressure continuing to moderate in a way that is similar to broader measures of wage growth.

This is encouraging, but it is not enough evidence to be sure it will continue. Just a couple of months ago, inflation and economic activity bounced back up, and the future was looking less certain. While it is encouraging to see inflation by the FOMC's preferred measure dipping below a 3 percent rate over the last three or six months, our target is 2 percent, and policy needs to be set at a level that moves inflation to 2 percent in the medium term. I will be closely monitoring the pressure on various categories of goods and services prices in the coming weeks to help me decide if inflation is continuing on its downward path.

Let me turn now to the implications of all this for monetary policy. I would start with the point I made at the outset—monetary policy is restrictive, and it is contributing to the rapid improvement in inflation in the last year. The FOMC raised the federal funds rate from near zero to more than 5 percent, the sharpest increase in more than 40 years, and, as some people have noted, we have seen the most rapid decline in inflation on record.

Elevated inflation was partly the result of supply-side problems related to the pandemic, and some of the improvement in inflation that we have seen has been due to the easing of those problems. But most data indicators and anecdotal evidence suggest that supply-side problems are largely behind us so they will provide little support in the future in returning inflation to our 2 percent goal. Monetary policy will have to do the work from here on out to get inflation back down to 2 percent.

There has been chatter that robust economic growth and falling inflation may be the result of higher labor productivity growth. Productivity growth over the last two quarters has averaged over 4 percent, more than double the long-term rate. However, measures of labor productivity are very noisy, and for the 15 quarters since the advent of the pandemic, productivity has increased at an annual rate of 1.4 percent, close to the 1.5 average over the past 15 years. So, relying on the productivity growth story to guide the current stance of monetary policy appears to be premature.

There has also been a lot of discussion about the overall easing of financial conditions this month, as reflected in market interest rates and the prices of other assets. To put this easing into perspective, from July to the end of October, the yield on the ten-year Treasury increased about 1 percentage point.

Since the FOMC's last meeting, which ended November 1, the ten-year rate has fallen six-tenths of a percentage point. Long-term interest rates are still higher than they were before the middle of the year, and overall financial conditions are tighter, which should be putting downward pressure on household and business spending. However, the recent loosening of financial conditions is a reminder that many factors can affect these conditions and that policymakers must be careful about relying on such tightening to do their job.

The October data I have cited on economic activity and inflation are consistent with the kind of moderating demand and easing price pressure that will help move inflation back to 2 percent, and I will be looking to see that confirmed in upcoming data releases. Before the next FOMC meeting, we will get data on PCE inflation and job openings, a job report, and a supply manager's survey for November. CPI inflation will come out on December 12, the first day of the FOMC meeting. All of that data will tell us whether inflation and aggregate demand are continuing to move in the right direction and inflation is on a path to our 2 percent goal.”

On Tuesday, Fed’s Bowman said:

·         I favor hiking rates if progress on inflation stalls

·         Investment encouraged by the Chips Act, and the Inflation Reduction Act could boost productive capacity, and may also increase inflationary pressures

·         The Fed policy rate may need to be at a higher level than before the pandemic to foster low, stable inflation

·         It is unclear if more supply-side advances will curb inflation

·         Risk energy prices may hurt inflation improvements

·         I am going to watch the data closely to assess the appropriate policy path

·         I see a risk of inflation from higher service consumption

Conclusion

“In conclusion, I continue to see an unusually high level of uncertainty as I consider current economic conditions and my views on the outlook for the economy and monetary policy. My colleagues and I will continue to make our monetary policy decisions at each meeting based on the incoming data and the implications for the economic outlook. I remain willing to support raising the federal funds rate at a future meeting should the incoming data indicate that progress on inflation has stalled or is insufficient to bring inflation down to 2 percent in a timely way.

We should keep in mind the historical lessons and risks associated with prematurely declaring victory in the fight against inflation, including the risk that inflation may settle at a level above our 2 percent target without further policy tightening. Returning inflation to the FOMC's 2 percent goal is necessary to achieve a sustainably strong labor market and an economy that works for everyone.”

On Tuesday, Fed’s Goolsbee said:

·         Overall, we have made good progress on inflation

·         Inflation is coming down but is not yet back to the target

·         The Fed has made progress on inflation outside of food prices

On Tuesday, the Fed funds futures market priced in a -100 bps rate cut in 2024 after dovish talks by Fed’s Waller. Subsequently, Gold and Wall Street futures jumped on hopes of a Fed pivot/pause. But Waller didn’t talk about any new policy outlook/stance, which the market does not know.

Conclusion:

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 to +5.00% and keep the real rate around +2.0% (compared to core CPI), still in the restrictive zone. In 2025, the Fed may further cut -2.0% for a repo rate of +3.00% against likely core CPI of around +2.00%. The market is now assuming the first Fed rate cut in June vs prior July after a softer-than-expected October NFP/BLS job report. Also, Fed swaps showed more than -100 bps of easing prices for 2024!

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.

Bottom line:

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 Fed may start cutting rates from June or July’24 and nay 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 stance.

Market wrap:

On Tuesday, Wall Street Futures and gold surged on dovish talks by Fed’s Waller, indicating an early rate cut. Oil recovered from OPEC+ production cut uncertainty low as storms disrupted oil and product exports from Russia’s Novorossiysk port. Gold jumped from around 2020 to 2042, while oil recovered from around 74.65 to 77.00; blue chip Dow Future surged around +0.28%, while tech-heavy NQ-100 Future also inched up +0.30%, stumbling from the session high to some extent on lingering uncertainty about Gaza war permanent ceasefire.

On Tuesday, Wall Street was boosted by consumer discretionary, real estate, consumer staples, communication services, utilities, materials, techs, and energy to some extent, while dragged by healthcare, industrials and banks & financials; interest rate sensitive and retail stocks helped on hopes of an early Fed rate cut and blockbuster retail sales (Black Friday and Cyber Monday), surged almost +10% (y/y). Dow Jones was boosted by 3M, Boeing, Microsoft (analyst upgrade), Walmart and Nike, while dragged by Walt Disney, Merck, Travelers, Walgreens Boots and United Health.

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

Whatever may be the narrative, technically Dow Future (35455), now has to sustain over 35450-35550 levels for a further rally to 35650/35750-35850/36000 and a further 37300 in the coming days; on the other side, sustaining below 35350-35250, Dow Future may again fall to 35000-34800/34650-34120/34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (16040) now has to sustain over 16200 for a further rally to 16700-16800 zones; otherwise sustaining below 16150-16050, may again fall to around 15100-14140 in the coming days.

Technically Oil (76.61) now has to sustain over 77.50-79.50 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: 2041) now has to sustain over 2050 for any further rally to 2065/2075-2085 areas.; otherwise sustaining below 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).