Gold, Dow, and Nasdaq soared on a dovish hold by Fed; USD slid

On Tuesday, Wall Street (US stocks) was boosted, while Gold slipped by hopes of a soft landing, an early end of the Gaza War, and largely in line with market expectations of core CPI data. In a way, the market was expecting the first Fed rate cut in May’24 rather than Mar’24. On Wednesday, apart from ongoing Israel-Gaza war tensions, all focus of the market was also on the Fed’s policy decision, where the Fed was expected to hold the rate with an indication of rate cuts in the coming quarters (2024); i.e. dovish hold stance. The actual focus of the market was on the Fed’s latest SEP/Dot-plots to gauze the Fed’s projection of rate cuts and core PCE inflation for 2024.

On early Wednesday, before the Fed, Gold and Wall Street Futures also got some boost after softer than expected US PPI/core PPI data for November, which may translate into softer core inflation going forward. Overall, Wall Street Futures and Gold jumped, and USD slumped after Fed statement/SEP data and also Chair Powell’s remarks, as both sounded more dovish than expected. Fed indicated -75 bps rate cuts from early 2024, and not from H2CY24, which was being expected by some market analysts after less dovish Powell talks on 1st December, in which he termed the speculation of an early rate cut in 2024 as ‘premature’.

Although Powell didn’t indicate any specific timeline/meeting from when the Fed may start cutting rates, unlike his last public comments on 1st December, Powell didn’t term the current market pricing of an early rate cut in 2024 as ‘purely speculative or premature’. Fed Chair Powell blinked on 13th December after sounding hawkish on 1st December, when he even talked about another rate hike in the coming months instead of a cut as the Fed is still not confident enough about the restrictive rate levels and thus prepared to hike further if it sees core inflation is not slowing fast enough.

The tectonic shift in Powell’s jawboning language comes as the US10Y bond yield was on the verge of breaking +5.0% levels, which was seen as a red line by the Treasury/White House amid surging borrowing costs for the huge public debt of Uncle Sam, world’s largest economy. U.S. is already paying around 10% of revenue as interest on public debt, which is almost double that of comparable economies (EU and China). In any way, on Wednesday before the Fed, the market was expecting a -100 bps rate cut in 2024, whereas the Fed projected a -75 bps rate cut and after the Fed, the market is now expecting a -150 bps rate cut in 2024. And Fed Swaps price policy rate under 4% by Dec’24.

Subsequently on Wednesday, Wall Street Futures and gold jumped, while the USD slumped as the Fed is now ‘officially and actively’ discussing rate cuts trajectory in 2024 (if the economy performs broadly as per Fed’s SEP projections). Fed has now officially shifted from a tightening to a neutral stance and no longer actively pursuing a ‘higher for longer’ policy. Fed will now actively discuss (jawbone) about time & extent of rate cuts in the coming months. Also, contrary to the earlier position, Fed/Powell is now open to stopping QT before it starts rate cuts.

Overall, the Fed will be in a calibrated loosening mode (from tightening) to balance inflation, employment, and economic growth ahead of Nov’24 U.S. Presidential Election. Both the Fed and White House would like to see a Goldilocks economy in 2024 rather than too hot or too cold to ensure a proper balance between cost of living (price stability) and maximum/inclusive broad-based quality employment. Thus the debate will be now whether the Fed will cut -75 bps (3 times) -100 bps (4 times/each QTR) or even -150 bps (6 times) in 2024, depending upon the actual trajectory of core inflation.

On Wednesday, the U.S. Fed held all primary policy rates as unanimously expected; i.e. the target range for the Federal Fund's Rate (FFR-interbank rate) at +5.38% (5.25%-5.50%); primary credit rate (repo rate) at +5.50%; IOER (reverse repo rate) at +5.40%; overnight repurchase agreement rate (RP) at +5.50% and RRP (Overnight Reverse Repurchase Agreement Rate) at +5.30%, keeping U.S. borrowing costs to the highest level since January 2001 (22-years) as US core CPI inflation is still quite elevated at around +4.0%, while the unemployment rate continues to be around historical low, at 3.7% and below Feed’s longer-term sustainable target of 4.0%.

On Wednesday, FOMC Policymakers said that recent indicators suggest that economic growth has slowed job gains have moderated but remain strong, and the unemployment rate has remained low. Core inflation has eased over the last year but remains elevated.

In its latest SEP (Summary of Economic Projections), the Fed estimated real GDP growth higher for 2023 (2.6% vs 2.1% in the September projection), but slightly lower in 2024 (1.4% vs 1.5%). Also, PCE inflation was revised lower for both 2023 (2.8% vs 3.3%) and 2024 (2.4% vs 2.5%) as well as core PCE inflation which is seen at 3.2% in 2023 (vs 3.7%) and 2.4% (vs 2.6%) in 2024. Unemployment projections remained steady at 3.8% for 2023 and 4.1% for 2024.

The so-called dot-plot now shows the median year-end 2024 projection for the Federal Funds Rate (FFR) fell to 4.6% from the earlier projection of 5.1% seen in September. Overall, Fed is projecting -75 bps rate cuts in 2024 vs earlier September projection of -50 bps; -100 bps in 2025 (vs -100 bps); -75 bps in 2026 (vs -100 bps), and -0.50 bps in 2027 (vs -75 bps); i.e. Fed is now front-loading rate cuts ahead of Nov’24 U.S. Presidential Election.

 

Highlights of Fed’s statement: 13th December’2023

·         US Interest Rate Decision Actual 5.5% (Forecast 5.5%, Previous 5.5%)

·         FOMC median forecast shows 75 bps of rate cuts in 2024 to 4.6% (FFR)

·         Inflation eased over the past year but remains elevated

·         FOMC median 2024 growth projection at 1.4% vs. prior 1.5%

·         Economic growth has slowed from a strong pace in Q3

·         The FOMC vote was unanimous

·         Median forecast shows rates (FFR) at 3.6% in 2025, 2.9% in 2026, while 4.6% at 2024

·         Median 2024 unemployment projection is unchanged at 4.1%

·         Tighter financial, and credit conditions weigh on the economy

·         Will continue the same pace of reducing Treasury & MBS holdings (QT)

·         Will continue bond-holding reductions as previously planned

·         FOMC median forecast shows 75 bps of rate cuts in 2024 to 4.6%

·         Inflation eased over the past year but remains elevated

·         The median 2024 growth projection at 1.4% vs. prior 1.5%

·         FOMC rate forecasts show a wide range of projections for 2024

·         Economic growth has slowed from a strong pace in Q3

·         Fed officials' median view of the Fed funds rate at the end-2024 4.6% versus the current 5.4% policy rate

·         Fed Officials' median view of fed funds rate at end-2025 3.6% (prior 3.9%)

·         Fed Officials' median view of Fed funds rate at end-2026 2.9% (prior 2.9%)

·         FOMC median 2024 PCE & core PCE inflation forecasts decline to 2.4%

·         Fed Officials' median view of fed funds rate in the longer run 2.5% (prior 2.5%)

·         Fed officials see inflation at 2.4% in 2024, returning to 2% target in 2026

·         Fed policymakers see weaker GDP growth and the same unemployment rate in 2024 compared with the September projections

·         Fed projections show that 8 of 19 officials see the policy rate above the 2024 median, 5 see it below that

·         No policymaker sees the end-2024 policy rate above the current level

Full text of Fed’s statement: 13th December 2023- Federal Reserve issues FOMC statement

“Recent indicators suggest that growth of economic activity has slowed from its strong pace in the third quarter. Job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated.

The U.S. banking system is sound and resilient. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The Committee will continue to assess additional information and its implications for monetary policy.

In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time; the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals. The Committee's assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action was Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Adriana D. Kugler; Lorie K. Logan; and Christopher J. Waller”

Implementation Note issued December 1, 2023: Decisions Regarding Monetary Policy Implementation

“The Federal Reserve has made the following decisions to implement the monetary policy stance announced by the Federal Open Market Committee in its statement on December 13, 2023:

The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate paid on reserve balances at 5.4 percent, effective December 14, 2023.

As part of its policy decision, the Federal Open Market Committee voted to direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:

"Effective December 14, 2023, the Federal Open Market Committee directs the Desk to:

Undertake open market operations as necessary to maintain the federal funds rate in a target range of 5-1/4 to 5-1/2 percent.

Conduct standing overnight repurchase agreement operations with a minimum bid rate of 5.5 percent and with an aggregate operation limit of $500 billion.

Conduct standing overnight reverse repurchase agreement operations at an offering rate of 5.3 percent and with a per-counterparty limit of $160 billion per day.

Roll over at auction the amount of principal payments from the Federal Reserve's holdings of Treasury securities maturing in each calendar month that exceeds a cap of $60 billion per month. Redeem Treasury coupon securities up to this monthly cap and Treasury bills to the extent that coupon principal payments are less than the monthly cap.

Reinvest into agency mortgage-backed securities (MBS) the amount of principal payments from the Federal Reserve's holdings of agency debt and agency MBS received in each calendar month that exceeds a cap of $35 billion per month.

Allow modest deviations from stated amounts for reinvestments, if needed for operational reasons.

Engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS transactions."

In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve the establishment of the primary credit rate at the existing level of 5.5 percent.”

Full text of Fed Chair Powell’s opening statement: 13th December’2023:

My colleagues and I remain squarely focused on our dual mandate to promote maximum employment and stable prices for the American people. As we approach the end of the year, it is natural to look back on the progress that has been made toward our dual mandate objectives. Inflation has eased from its highs, and this has come without a significant increase in unemployment. That is very good news. But inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain. As we look ahead to next year, I want to assure the American people that we are fully committed to returning inflation to our 2 percent goal. Restoring price stability is essential to achieve a sustained period of strong labor market conditions that benefit all.

Since early last year, the FOMC has significantly tightened its stance on monetary policy. We have raised our policy interest rate by 5-1/4 percentage points and have continued to reduce our securities holdings at a brisk pace. Our actions have moved our policy rate well into restrictive territory, meaning that tight policy is putting downward pressure on economic activity and inflation, and the full effects of our tightening likely have not yet been felt.

Today, we decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings. Given how far we have come, along with the uncertainties and risks that we face, the Committee is proceeding carefully. We will make decisions about the extent of any additional policy firming and how long policy will remain restrictive based on the totality of the incoming data, the evolving outlook, and the balance of risks.

I will have more to say about monetary policy after briefly reviewing economic developments.

Recent indicators suggest that the growth of economic activity has slowed substantially from the outsized pace seen in the third quarter. Even so, GDP is on track to expand around 2-1/2 percent for the year as a whole, bolstered by strong consumer demand as well as improving supply conditions. After picking up somewhat over the summer, activity in the housing sector has flattened out and remains well below the levels of a year ago, largely reflecting higher mortgage rates. Higher interest rates also appear to be weighing on business fixed investment. In our Summary of Economic Projections, Committee participants revised their assessments of GDP growth this year but expect growth to cool, with the median projection falling to 1.4 percent next year.

The labor market remains tight, but supply and demand conditions continue to come into better balance. Over the past three months, payroll job gains averaged 204 thousand jobs per month, a strong pace that is nevertheless below that seen earlier in the year. The unemployment rate remains low, at 3.7 percent. Strong job creation has been accompanied by an increase in the supply of workers: The labor force participation rate has moved up since last year, particularly for individuals aged 25 to 54 years, and immigration has returned to pre-pandemic levels.

Nominal wage growth appears to be easing, and job vacancies have declined. Although the jobs-to-workers gap has narrowed, labor demand still exceeds the supply of available workers. FOMC participants expect the rebalancing in the labor market to continue, easing upward pressures on inflation. The median unemployment rate projection in the SEP rises somewhat from 3.8 percent at the end of this year to 4.1 percent at the end of next year.

Inflation has eased over the past year but remains above our longer-run goal of 2 percent. Based on the Consumer Price Index and other data, we estimate that total PCE prices rose 2.6 percent over the 12 months ending in November; and that, excluding the volatile food and energy categories, core PCE prices rose 3.1 percent. The lower inflation readings over the past several months are welcome, but we will need to see further evidence to build confidence that inflation is moving down sustainably toward our goal.  

Longer-term inflation expectations appear to remain well anchored, as reflected in a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets. As is evident from the SEP, we anticipate that the process of getting inflation to 2 percent will take some time. The median projection in the SEP is 2.8 percent this year, falls to 2.4 percent next year, and reaches 2 percent in 2026.

The Fed’s monetary policy actions are guided by our mandate to promote maximum employment and stable prices for the American people. My colleagues and I are acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. We are highly attentive to the risks that high inflation poses to both sides of our mandate, and we are strongly committed to returning inflation to our 2 percent objective.

As I noted earlier, since early last year, we have raised our policy rate by 5-1/4 percentage points, and we have decreased our securities holdings by more than $1 trillion. Our restrictive stance on monetary policy is putting downward pressure on economic activity and inflation. The Committee decided at today’s meeting to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent and to continue the process of significantly reducing our securities holdings.

While we believe that our policy rate is likely at or near its peak for this tightening cycle, the economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2 percent inflation objective is not assured. We are prepared to tighten policy further if appropriate. We are committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation sustainably down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective.

In our SEP, FOMC participants wrote down their individual assessments of an appropriate path for the federal funds rate based on what each participant judged to be the most likely scenario going forward. While participants do not view it as likely to be appropriate to raise interest rates further, neither do they want to take the possibility off the table. If the economy evolves as projected, the median participant projects that the appropriate level of the federal funds rate will be 4.6 percent at the end of 2024; 3.6 percent at the end of 2025; and 2.9 percent at the end of 2026; still above the median longer-term rate. These projections are not a Committee decision or plan; if the economy does not evolve as projected, the path for the policy will adjust as appropriate to foster our maximum employment and price stability goals.

In light of the uncertainties and risks, and how far we have come, the Committee is proceeding carefully. We will continue to make our decisions meeting by meeting, based on the totality of incoming data and their implications for the outlook for economic activity and inflation as well as the balance of risks.

In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.

We remain committed to bringing inflation back down to our 2 percent goal and to keeping longer-term inflation expectations well anchored. Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run.

To conclude, we understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission. We at the Fed will do everything we can to achieve our maximum employment and price stability goals.”

Highlights of Fed Chair Powell’s comments in the Q&A: 13th December

·         Higher interest rates are also weighing on business fixed investment apart from household consumption

·         Growth in economic activity has slowed substantially

·         Activity in the housing sector has flattened out

·         The full effects of tightening are likely not yet felt

·         We will make future decisions on the totality of data, evolving outlook, and incoming risks

·         Given how far we've come and given the uncertainties, we are proceeding carefully

·         We're well into restrictive territory

·         The path forward uncertain

·         Nominal wage growth appears to be easing

·         The labor market remains tight but is coming into better balance

·         We expect the labor market easing to continue

·         Labor demands are still exceeding supply though

·         We estimate core PCE prices rose 3.1% in 12 months ending November

·         Policymakers expect labor market rebalancing to continue

·         We anticipate getting inflation to 2% will take some time

·         The lower inflation readings over the last several months are welcome

·         The Fed estimates the November PCE prices up 2.6% YoY, with core up 3.1%

·         We're prepared to tighten policy further if appropriate

·         While we believe our policy rate is likely near its peak for this cycle, we have been surprised in the past

·         Policymakers don't want to take the possibility of further hikes off the table

·         We will keep policy restrictive until we're confident we're on the path to 2% inflation

·         We added the word "any" to show that we thought we were likely at or near peak for rates

·         No one is declaring victory, that would be premature

·         We are seeing strong growth that appears to be moderation, and inflation making real progress

·         Policymakers are thinking and talking about when it will be appropriate to cut rates

·         It is not likely we will hike further

·         We are still focused on the question of whether rates are high enough

·         On rate cuts, that begins to come into view and is now a topic of discussion

·         There's little basis for thinking the economy is in recession now, but there's always a probability there will be a recession in the next year

·         There was a general expectation that rate cuts would be a topic of conversation going forward

·         I have always felt there was a possibility economy could avert recession while inflation came down, and so far that's what we are seeing. That said, the result is not guaranteed

·         This is the year when distortions from the pandemic are unwound

·         The difference in the projections reflects lower inflation than previously expected

·         The expectation would be that real rates will decline as we move forward

·         Policymakers are thinking we have done enough, but we are not fully confident in that view yet

·         It's really good to see the progress we are making on inflation, we're still well above 3% on core PCE though

·         If we have stronger growth, that will be good but will mean it takes longer to get inflation back down

·         Above-trend growth could ultimately mean that we need to hike again

·         On the labor market, wages still running a bit above what is consistent with a 2% inflation

·         We are aware of the risk that we could hang on too long on rates. We're very focused on not making that mistake

·         We've seen reasonable progress in non-housing services inflation

·         You need to reduce restrictions on the economy well before 2%

·         We think the supply-side help for inflation has some ways to run

·         We are not talking about altering the pace of QT right now

·         We're not at the level of reserves when would need to slow or stop balance sheet runoff

Overall, Fed Chair Powell looked relaxed about his achievement in securing a soft & safe landing for the U.S. economy by bringing down inflation without causing any significant slowdown in the labor market; on the contrary, real GDP growth was also way above trend due to certain factors. Powell also sounded less hawkish or rather than dovish compared to his last public comments on 1st December; political (White House and Treasury/Yellen) pressure is weighing on the Fed in the 2024 election year.

Conclusions:

If the US core CPI index grew by around +0.2% in Dec’23, the annual rate of core CPI would again come around +4.0%, translating to around +4.8% average core CPI for 2023. If US core CPI indeed dips below +3.0% by May-June’24 and if it seems that the 2024 average core inflation will be around +3.25%, then the Fed may start cutting rates from July’24 and may cut cumulatively 75-100 bps at -0.25% pace till Dec’24 for a repo rate at 4.75-4.50%, so that real rate continues to stand around +1.50%, in line with present restrictive stance (5.50% repo rate-4.00% average core CPI for last 6M).

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 10% 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.

Bottom line:

Considering all pros & cons, Fed may wait for core inflation data (average for core PCE and core CPI) for at least Dec’23-Mar’24 and if it goes down to around +4.00% from the projected 2023 average of +4.5% (4.80% core CPI and +4.20% core PCE), the Fed may cut rep rates/FFR by -25 bps in June; further if such disinflation trend continues, Fed may cut -25 bps each in September and December for a cumulative -75 bps. And if average core inflation slid more than expected, then the Fed may cut from March-May’23 for -100 bps cumulatively.

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

Whatever may be the narrative, technically Dow Future (37250), now has to sustain over 37500 levels for a further rally in the coming days; otherwise, sustaining below 37400/37300 may fall to 37000-36850-36650 levels may again fall to 36400/36200-36050/36000-35800/35500 and may further fall to 35350/35250-35000/34800 and 34650/34120-34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (16670) now has to sustain over 16900 for a further rally; otherwise sustaining below 16800/700, may fall to 16500/16250, and further 16100/16050-15700/15400, and further 15100-14140 in the coming days.

Also, technically Gold (XAU/USD: 2040) now has to sustain over 2055 for a further rally to 2065/2075-2130/2150 levels; otherwise sustaining below 2050/2040, may fall to 2020/2000-1975-1960/1950 and 1928/1908 in the coming days.