Gold and Dow surged on softer US core CPI; USD plunged

On Monday, Wall Street futures closed almost flat amid lingering suspense about the Gaza war ceasefire and the limited impact of Moody’s US outlook downgrade. The market was also cautious ahead of the U.S. core CPI report Tuesday. The Fed is now clearly on hold at +5.50% repo rates since the last hike of +0.25% in July, but emphasizing on ‘higher for longer’ policy. Fed is going for a hawkish hold policy action/stance as 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.

On Tuesday, apart from the ongoing Gaza war trajectory, all focus of the market was also on U.S. core CPI inflation for October as it may influence the Fed for any rate action/stance on 13th December. Although the market is already discounting a pause in December, but Fed may still evaluate core CPI data for October and November for its SEP on 13th December and policy stance for H1CY24/Q1CY24.

On Tuesday, the BLS data showed the annual US core inflation (seasonally not adjusted core CPI) further eased to +4.0% in October from +4.1% sequentially, lower than the market consensus of +4.1% and the lowest since Sep’21. In Oct’22, the annual core CPI was +6.3%, and +5.6% in Jan’23; i.e., the core CPI has reduced by almost -2.30% in the last 13 months, which is almost -0.20% per month on an average. At this run rate, core CPI should be around +3.5% by Dec’23, +3.0% by Dec’24, and +2.0% by Dec’25 - at target in line with the Fed’s estimate of Dec’25 (after considering some volatility due to elevated oil prices).

The U.S. Core service inflation (w/o energy service) also eased to +5.5% in October from +5.7% sequentially and Jan’23 reading of +7.2%, it’s still substantially above pre-COVID average levels of 2.8%. Fed is now closely focusing on core service inflation, which is still quite elevated and sticky.

In Oct’23, the shelter index, accounting for over 70% of the total increase in all items less food and energy, slowed to 6.7% from 7.2% in the prior month. The indexes for recreation (3.2% vs 3.9%), personal care (6% vs 6.1%), and household furnishings and operations (1.7% vs 1.9%) also exhibited smaller price increases, while that for motor vehicle insurance climbed further (19.2% vs 18.9%).

On Tuesday, the BLS data showed the sequential (m/m) US core CPI (seasonally adjusted) rose +0.2% in October from +0.3% in September, below market expectations of +0.3% advance. In Oct’23, Consumer prices decelerated for services fewer energy services (0.3% vs 0.6% in September), and fell for the fifth consecutive period for commodities less food and energy commodities (-0.1% vs -0.4%).

Fed needs +0.2% sequential core CPI consistently for its annual core CPI target of +2.0% on a sustainable basis. Overall, the 3M rolling average of underlying core CPI may be now running around +4.1% and if October core PCE inflation comes around +3.6% (sequential rate +0.2% - in line with core CPI), the average core inflation (CPI+PCE) would be around +3.9% in Oct’23

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On Tuesday, the BLS data also showed annual (y/y) total/headline CPI rose by +3.2% in Oct’23 from +3.7% sequentially, below the market expectations of +3.3%. In Oct’23, energy costs dropped 4.5% (vs -0.5% in September), with gasoline declining 5.3%, utility (piped) gas service falling 15.8% and fuel oil sinking 21.4%. Additionally, prices increased at a softer pace for food (3.3% vs. 3.7%), shelter (6.7% vs. 7.2%) and new vehicles (1.9% vs. 2.5%) and continued to decline for used cars and trucks (-7.1%).

On the other hand, prices rose faster for apparel (2.6% vs. 2.3%), medical care commodities (4.7% vs. 4.2%), and transportation services (9.2% vs. 9.1%). Compared to September, the CPI was unchanged, the least in fifteen months, and below forecasts of a 0.1% rise, as lower gasoline prices (-5%) offset increases in prices for shelter (0.3%), natural gas (1.2%) and food (0.3%).

On a sequential (m/m) basis, the headline CPI (seasonally adjusted) eased to +0.0% in October from +0.4% in September and above the market consensus of +0.1% increase. In Oct’23, the index for shelter continued to rise (0.3 percent vs 0.6 percent in September), offsetting a decline in the gasoline index (-5 percent vs 2.1 percent). The energy index fell 2.5 percent over the month as a 5.0-percent decline in the gasoline index more than offset increases in other energy component indexes. The food index increased 0.3 percent, after rising 0.2 percent. The index for food at home increased 0.3 percent (vs 0.1 percent) while the index for food away from home rose 0.4 percent (the same as in September).

The 3M rolling average of underlying total CPI may now be running around +3.9% against the core CPI of +4.1%.

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.

Market wrap:

On Tuesday, Wall Street, Gold jumped on softer than expected core CPI, which may keep the Fed on a less hawkish hold stance and hopes of an early rate cut (by May’24 instead of July-Sep’24). There was no fresh significant news of Gaza war front escalation/ceasefire, but Israel is also thinking hard stance against the ongoing Hezbollah attack. Blue Chip DJ-30 jumped almost +500 points, broader SPX-500 surged +1.9%, while tech-heavy NQ-100 soared +2.40% led by Nvidia, Tesla (China/India optimism), Meta and Amazon (JV between these two giants; clients may buy Amazon products directly from Meta platform). On Tuesday, Wall Street was boosted by real estate, utilities, consumer discretionary, materials, banks & financials, techs, communication services, consumer staples, healthcare and energy.

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

Whatever the narrative, technically Dow Future (34917), now has to sustain over 35200 for a further rally to 35350/35500-35650/35850 in the coming days; on the other side, sustaining below 35150, Dow Future may again fall to 34800/34650-34120/34000 and 33700/33200-33000/32400 in the coming days.

 

Similarly, NQ-100 Future (15900), now has to sustain over 16100 for a further rally; otherwise sustaining below 16050, may again fall to around 16100-14140 in the coming days.

Whatever the narrative, technically Gold (XAU/USD: 1963) now has to sustain over 1975 for any further rally to 1980/1995-2008/2012 and 2063-2085 for a further rally to 2022/2038-2055/2085; otherwise sustaining below 1970, may further fall to 1955/1932-1923 and 1908/1904-1895/1885 and 1850/1810 in the coming days (if there was a Gaza war ceasefire).