Hawkish Fed cut spoiled year-end Santa rally at Wall Street

·         Gold, Stocks slid even after the expected Fed rate cut as it projected a 50 bps cumulative cut in 2025 instead earlier 100 bps

·         Fed already cut an additional 50 bps in H2CY25 despite stalled core disinflation and thus may cut next in June and Dec’25

·         Fed also cut ONRRP by -30 bps to 4.25% instead of 25 bps to ensure the smooth functioning of the funding market and to avoid another disruption like late 2019

·         Lower risk-free assured return from the Fed through ONRRP is negative for banks & financials to some extent

On Wednesday (18th Dec’24) all focus of the market was on the FOMC meeting and the Fed’s policy decisions, whether the Fed also synchronizes with its translantic colleague ECB. As highly expected, the Fed cut all of its key policy rates by 25 bps and 30 bps for ON RRP. Fed cut target range for the Federal Fund's Rate (FFR-interbank rate-SOFR) to 4.38%% (median of 4.50-4.25%); primary credit rate (repo rate) +4.50%; IOER (reverse repo rate) +4.40%; overnight repurchase (ONRP) agreement rate (ON RP) +4.50% and ONRRP (Overnight Reverse Repurchase Agreement Rate) to +4.25%.

On 18th Dec’24, the Fed reduced ONRRR by -30 bps instead of -25 bps to ensure a smooth money/funding market. Fed said:

·         Setting this rate at the bottom of the target range for the federal funds rate is intended to support effective monetary policy implementation and the smooth functioning of short‑term funding markets

·         On a technical note, we lowered the offering rate on our overnight reverse repo facility to align it with the bottom of the target range for the federal funds rate—its typical configuration. Technical adjustments of this kind have no bearing on the stance of monetary policy.

As banks get lower ONRRP rates from the Fed, it will deploy more funds into lending to each other for higher rates, which will ensure the smooth functioning of the funding/money market and may prevent late 2019 like REPO/funding market crisis in the coming days as Fed is now approaching critical ending phase of QT, which may disrupt US funding market. Fed may keep its B/S size around 20-22% of projected nominal GDP around $30T for 2025-26. Fed may keep around $6.50-6.60T B/S size for the longer term, which now stands around $6.9T. Overall, lower ONRRP is negative for banks & financials to some extent as it will earn slightly lower risk-free returns from the Fed.

On Wednesday, the Fed cut -25 bps for December’24, marking the third consecutive rate cut in 2024, cumulating -100 bps, which is in line with market expectations. But the Fed indicated a cautious approach in dialing back of restrictive rate further in 2025-26 amid stalled core disinflation or stickier than expected core inflation, robust labor market, and resilient US economic activities/GDP growths coupled with Trump 2.0 policy uncertainty, especially on immigration/deportations and tariffs, which may affect both labor market and price stability (inflation) in a meaningful way.

On Wednesday, Fed’s Dec’24 median dot-plot projections show only 50 bps cumulative rate cuts each in 2025-27, totaling -150 bps for a terminal/longer run repo rate vat +3.00% by 2027 against earlier Sep’24 dot-plot of cumulative -100 bps rate cut in 2025, -50 bps each in 2026-27. The US rate futures price in just two rate cuts @25 bps in 2025 after the Fed’s latest dot-plots against earlier four. Subsequently Wall Street Futures Gold, and Silver slumped as the Fed almost poured cold water on the early Santa party.

On Wednesday, the Fed’s December SEP (summary of economic projections) also shows the Fed revised the US real GDP growth forecasts upward for 2024 (2.5% vs. 2% in the September projection) and 2025 (2.1% vs 2%), while unchanged at 2% for 2026. Similarly, the Fed projected core PCE inflation higher for 2024 (2.8% vs 2.6%), 2025 (2.5% vs 2.2%), and 2026 (2.2% vs 2.0%). On the other hand, unemployment is seen lower this year (4.2% vs 4.4%) and in 2025 (4.3% vs 4.4%) while the forecast was kept at 4.3% for 2026.

Full text of Fed’s statement: December 18, 2024

Federal Reserve issues FOMC statement

“Recent indicators suggest that economic activity has continued to expand at a solid pace. Since earlier in the year, labor market conditions have generally eased, and the unemployment rate has moved up but remains low. Inflation has made progress toward the Committee's 2 percent objective but remains somewhat elevated.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. The Committee judges that the risks to achieving its employment and inflation goals are roughly in balance. The economic outlook is uncertain, and the Committee is attentive to the risks to both sides of its dual mandate.

In support of its goals, the Committee decided to lower the target range for the federal funds rate by 1/4 percentage point to 4-1/4 to 4-1/2 percent. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The Committee will continue reducing its holdings of Treasury securities agency debt and agency mortgage‑backed securities. The Committee is strongly committed to supporting maximum employment and 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 were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Thomas I. Barkin; Michael S. Barr; Raphael W. Bostic; Michelle W. Bowman; Lisa D. Cook; Mary C. Daly; Philip N. Jefferson; Adriana D. Kugler; and Christopher J. Waller. Voting against the action was Beth M. Hammack, who preferred to maintain the target range for the federal funds rate at 4-1/2 to 4-3/4 percent.”

Implementation Note issued December 18, 2024:

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 18, 2024:

·         The Board of Governors of the Federal Reserve System voted unanimously to lower the interest rate paid on reserve balances to 4.4 percent, effective December 19, 2024.

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 19, 2024, 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 4-1/4 to 4-1/2 percent

·         Conduct standing overnight repurchase agreement operations with a minimum bid rate of 4.5 percent and with an aggregate operation limit of $500 billion.

·         Conduct standing overnight reverse repurchase agreement operations at an offering rate of 4.25 percent and with a per-counterparty limit of $160 billion per day. Setting this rate at the bottom of the target range for the federal funds rate is intended to support effective monetary policy implementation and the smooth functioning of short‑term funding markets.

·         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 $25 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 the amount of principal payments from the Federal Reserve's holdings of agency debt and agency mortgage‑backed securities (MBS) received in each calendar month that exceeds a cap of $35 billion per month into Treasury securities to roughly match the maturity composition of Treasury securities outstanding

·         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 a 1/4 percentage point decrease in the primary credit rate to 4.5 percent, effective December 19, 2024

Full text of Fed Chair Powell’s opening statement: 18th December’24

“My colleagues and I remain squarely focused on achieving our dual mandate goals of maximum employment and stable prices for the benefit of the American people. The economy is strong overall and has made significant progress toward our goals over the past two years. The labor market has cooled from its formerly overheated state and remains solid. Inflation has moved much closer to our 2 percent longer-run goal.

We are committed to maintaining our economy’s strength by supporting maximum employment and returning inflation to our 2 percent goal. To that end, today, the Federal Open Market Committee decided to take another step in reducing the degree of policy restraint by lowering our policy interest rate by 1/4 percentage point. We also decided to continue to reduce our securities holdings. I will have more to say about monetary policy after briefly reviewing economic developments.

Recent indicators suggest that economic activity has continued to expand at a solid pace. GDP rose at an annual rate of 2.8 percent in the third quarter, about the same pace as in the second quarter. Growth of consumer spending has remained resilient, and investment in equipment and intangibles has strengthened. In contrast, activity in the housing sector has been weak.

Overall, improving supply conditions have supported the strong performance of the U.S. economy over the past year. In our Summary of Economic Projections, Committee participants generally expect GDP growth to remain solid, with a median projection of about 2 percent over the next few years.

In the labor market, conditions remain solid. Payroll job gains have slowed from earlier in the year, averaging 173 thousand per month over the past three months. The unemployment rate is higher than it was a year ago, but at 4.2 percent in November, it has remained low. Nominal wage growth has eased over the past year, and the jobs-to-workers gap has narrowed. Overall, a broad set of indicators suggests that conditions in the labor market are now less tight than in 2019. The labor market is not a source of significant inflationary pressures. The median projection for the unemployment rate in the SEP is 4.2 percent at the end of this year and 4.3 percent over the next few years.

Inflation has eased significantly over the past two years but remains somewhat elevated relative to our 2 percent longer-run goal. Estimates based on the Consumer Price Index and other data indicate that total PCE prices rose 2.5 percent over the 12 months ending in November; and that, excluding the volatile food and energy categories, core PCE prices rose 2.8 percent. 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. The median projection in the SEP for total PCE inflation is 2.4 percent this year and 2.5 percent next year, somewhat higher than projected in September. Thereafter, the median projection falls to our 2 percent objective.

Our monetary policy actions are guided by our dual mandate to promote maximum employment and stable prices for the American people. We see the risks to achieving our employment and inflation goals as being roughly in balance, and we are attentive to the risks on both sides of our mandate.

At today’s meeting, the Committee decided to lower the target range for the federal funds rate by 1/4 percentage point, to 4-1/4 to 4-1/2 percent. We have been moving policy toward a more neutral setting to maintain the strength of the economy and the labor market while enabling further progress on inflation. With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive. We can therefore be more cautious as we consider further adjustments to our policy rate.

We know that reducing policy restraint too fast or too much could hinder progress on inflation. At the same time, reducing policy restraint too slowly or too little could unduly weaken economic activity and employment. In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will assess incoming data, the evolving outlook, and the balance of risks. We are not on any preset course.

In our Summary of Economic Projections, 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. The median participant projects that the appropriate level of the federal funds rate will be 3.9 percent at the end of next year and 3.4 percent at the end of 2026. These median projections are somewhat higher than in September, consistent with the firmer inflation projection. These projections, however, are not a Committee plan or decision.

As the economy evolves, monetary policy will adjust to best promote our maximum employment and price stability goals. If the economy remains strong and inflation does not continue to move sustainably toward 2 percent, we can dial back policy restraint more slowly. If the labor markets were to weaken unexpectedly or inflation was to fall more quickly than anticipated, we could ease policy more quickly. The policy is well-positioned to deal with the risks and uncertainties that we face in pursuing both sides of our dual mandate.

On a technical note, we lowered the offering rate on our overnight reverse repo facility to align it with the bottom of the target range for the federal funds rate—its typical configuration. Technical adjustments of this kind have no bearing on the stance of monetary policy.

The Fed has been assigned two goals for monetary policy—maximum employment and stable prices. We remain committed to supporting maximum employment, bringing inflation sustainably to our 2 percent goal, and keeping longer-term inflation expectations well anchored. Our success in delivering on these goals matters to all Americans. 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. Thank you. I look forward to your questions.”

Highlights of FOMC policy statement: 18th Dec’24

·         Fed cuts by a quarter point, indicate fewer reductions ahead

·         US Interest Rate Decision Actual 4.5% (Forecast 4.5%, Previous 4.75%)

·         The Federal Reserve cuts rates by 25 basis points, as expected

·         The Fed policy statement is little changed from the November meeting statement, with the descriptions of the economy growing at a solid pace being identical

·         Four FOMC officials penciled in 25 bps or less of cuts for 2025

·         Fed lowers reverse repo rate by 30 basis points to 4.25% versus 25 bps cut to the Fed funds rate

·         The median view of the Fed funds rate at end-2027 3.1% (vs +2.9%)

·         The median view of the Fed funds rate at end-2025 3.9% (vs 3.4%)

·         The median view of the Fed funds rate at end-2024 4.4% (vs. 4.4%)

·         Fed sees risks to inflation and employment goals roughly in balance (the same as in the November statement)

·         Cleveland Fed’s President Hammack dissented in favor of no rate cut

·         Fed: In considering the extent and timing of additional rate adjustments the Fed will assess incoming data, evolving outlook and balance of risks

·         Fed sees a 2.1% GDP growth in 2025 versus 2.0% in September see longer-run growth at 1.8%, unchanged from September

·         Fed sees end-2025 PCE inflation at 2.5% versus 2.1% in September; the core is seen at 2.5% versus 2.2%

·         Fed sees a 4.3% unemployment rate at the end of 2025 versus 4.4% in September projections

·         Fed projections (dot-plots) show one of 19 officials see no cuts in 2025, 3 see one cut, 10 see 2 cuts, 3 see 3 cuts, one sees 4 cuts, one sees 5 cuts

·         Fed projections show a longer-run policy rate at 3.0% vs 2.9% in September projections

·         Fed projections imply 50 basis points of rate cuts in 2025, another 50 bps in 2026

·         Fed Median Rate Forecast (2025) Actual 3.875% (Forecast 3.625%, Previous 3.375%)

·         Fed Median Rate Forecast (2027) Actual 3.125% (Forecast 3.125%, Previous 2.875%)

·         Fed Median Rate Forecast (Current) Actual 4.375% (Forecast 4.375%, Previous 4.375%)

·         Fed Median Rate Forecast (Long Run) Actual 3% (Forecast 3%, Previous 2.875%)

·         Fed Median Rate Forecast (2026) Actual 3.375% (Forecast 3.125%, Previous 2.875%)

·         The policy statement hints at a slower pace of cuts by adding the phrase "the extent and timing" to modify potential adjustments

Highlights of Fed Chair Powell’s statements/comments in the Q&A: 18th Dec’24:

·         Consumer spending is resilient and investment in equipment (Private CAPEX) has strengthened

·         Economic activity has expanded at a solid pace

·         The labor market remains solid

·         We're squarely focused on two goals (dual mandate)

·         We can be more cautious as we consider more adjustments (rate cuts)

·         Today we lowered the range and have been moving toward a more neutral setting

·         Risks to achieving goals are roughly in balance

·         Total PCE probably rose 2.5% in the 12 months ending in November

·         The labor market is not a source of inflation pressures

·         Fed is not interested in weakening the labor market further

·         The policy is well-positioned to deal with risks

·         We can dial back policy restraint more slowly if inflation not moving sustainably toward 2%

·         Policymaker projections for the policy rate are higher for next year, consistent with higher inflation

·         Policy stance is now significantly less restrictive

·         Reducing policy restraint too slowly could unduly weaken the economy and employment

·         Today was a closer call

·         Job creation is below the level that would hold the jobless rate constant

·         The labor market is cooling in a gradual and orderly way

·         Downside labor market risks appear to have diminished

·         Housing services are steadily coming down

·         I see the inflation story as broadly on track

·         Risks and uncertainty around inflation we see as higher

·         The ''extent and timing'' language shows we are at or near the point of slowing rate cuts

·         We believe the policy is still meaningfully restrictive

·         We think the economy is in a really good place and policy too

·         What's driving a slower rate-cut path is stronger economic growth and lower unemployment

·         Some people did take a very preliminary step and incorporated conditional effects of coming Trump policies in their projections

·         Also driving a slower rate-cutting path is higher inflation this year and next year

·         Today was a 'closer call' but we decided it was the right call

·         Inflation is much closer to the 2% goal

·         November inflation is back on track after higher readings

·         We want to see progress on inflation as we think about further cuts and a solid labor market

·         Higher inflation is probably the biggest factor for the new projections

·         The committee is discussing ways in which tariffs can drive inflation; we've done a good bit of work on that

·         Higher inflation is probably the biggest factor for the new projections

·         It's premature to make any conclusion on the impact of tariffs; don't know what countries, what size, how long

·         Core inflation coming down to 2.5% next year, as in projections, would be significant progress

·         We are in a new phase in the process (rate cuts)

·         The labor market is not cooling in a way that raises concerns

·         It might take another year or two from here to get to 2% inflation targets

·         Goods inflation has returned to the pre-pandemic range overall

·         There's no reason to think a downturn is any more likely than usual

·         I expect another very good year next year

·         People are feeling the effect of high prices, not high inflation

·         Wages are at a healthy and evermore sustainable level

·         Fed's Powell, when asked about Bitcoin reserve: We're not allowed to own Bitcoin and not looking for a law change

·         We think our policy is working and having the effects we want

·         We still have some work to do on inflation; we need policy to remain restrictive to get the work done

·         A rate hike does not appear to be a likely outcome next year

·         We won't settle for above 2% inflation

·         We won't overreact to a couple of months of inflation prints

·         Geopolitical turmoil remains a risk

·         Today was a closer call but we decided it was the right call

·         From here, it’s a new phase, and we’re going to be cautious about further cuts

Conclusions

Despite unfavorable data, and Trump policy uncertainty Fed cut on 18th December’24 to catch up with synchronized global easing and also to keep differential with ECB, which cut -100 bps in 2024. Fed may have also made a policy mistake by not cutting rates by 50 bps in H1CY24 and thus now cutting 100 bps in H1CY24 to catch up. Fed may like to keep the repo rate at 4.5% against average core CPI inflation for 2024 around 3.5% for a real repo rate +1.0%, moderately restrictive, but lower than 2.0% in H1CY24, when the repo rate was 5.50% against average core CPI inflation +3.5%. Looking ahead, the Fed may like to keep the core real rate around +1.00% and cut gradually every six months till Dec’27 for a repo rate of +3.00% from +4.50% at present.

As US core inflation (CPI+PCE) almost stalled or even edged up in H2CY24 around +3.0% on average, while the unemployment rate remains stable at around 4.0% along with resilient Real GDP and PDPF growth around 2.9% on average, the Fed should have paused in December’24. However, the Fed may have missed the opportunity of two rate cuts in H1CY24 despite favorable core inflation data. Thus to catch up after the unemployment rate ticked up, the Fed cut a cumulative -100 bps cut in H2CY24 (by front-loading to stay ahead of the curve). Fed has to also synchronize with BOC, ECB, BOE, SNB, and various other European and APC central banks, most of which are in rate-cutting sprees like in a crisis to avert a looming stagflation or even an all-out recession.

Although the Fed generally talks about 2.0% PCE inflation as a price stability target, in reality, it maintains 1.5% core/total PCE inflation and 2.3% core/total CPI inflation; i.e. around 1.9% average inflation (PCE+CPI) targets, Congress has entrusted along with maximum employment 96.0-95.5% of the labor force; i.e. 4.0-3.5% headline unemployment rate. Fed will now try to bring down average core inflation from around 3.0% to 2.5% by keeping the unemployment rate at least around 4.0% by December’25 and then 2.0% core inflation and 3.5% unemployment rate by December’26 to achieve its mandate of maximum employment and price stability.

Thus the Fed cut on 18th December for a cumulative rate cut of 100 bps in 2024 to a repo rate of 4.50% against the average core CPI of 3.5% for 2024, so that the real repo rate remains around +1.00%. Fed may have made a policy mistake by not cutting from H1CY24 when 3MRA of core CPI was around +3.5% on average. Thus Fed is now cutting 50 bps extra in H2CY24 to stay ahead of the curve.

Bottom line:

Despite a 50 bps projected rate cut in 2025-26, the Fed may cut 100 bps each if Trump’s immigration and tariff policies are less hawkish in reality due to moderate Musk & Co., who may ensure good relations between Trump/US with China and Russia (Putin); Musk has not only good business relation with China but also a good ‘personal/diplomatic’ relation with Putin for the last few years.

Fed front-loaded 50 bps rate cuts for 2025 in H2CY24 and thus may cut only 50 bps in 2026. But the Fed may also change its stance in the coming months and go for 100 bps rate cuts in 2025 if the US unemployment rate ticked up towards 4.5%, while core CPI inflation ticked down below +3.0%. We have to keep in mind Fed often changes its goalposts to suit its narrative/stance/rate action even after contradictory jawboning. The Fed should maintain more credibility as the Fed is the de-facto central bank of the world and controls almost all types of financial asset classes, with USD being the undisputed preferred global trade & reserve currency.

In H1CY25, the Fed may also share some concrete plans to end the QT, which may be positive for UST and negative for US bond yields, USD. Lower borrowing costs/lower bond yield would be also positive for stocks and higher bond prices may also boost gold to some extent.

Market Impact:

Wall Street Futures slid on less dovish or fewer than expected Fed rate cuts in 2025; Gold and Silver also stumbled.  Also year-ending US debt crisis ritual affected Wall Street, while supporting Gold to some extent. On Thursday, hotter-than-expected US GDP data also dragged Gold and even Wall Street, despite soft landing optimism. Dow Future was in a downturn for the 9/10 consecutive trading sessions, not seen since 1974. Fed out may now be in jeopardy under Trump 2.0.

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

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 45100) now has to sustain over 45500 for any further rally to 45800/46000-46200/46400 and 46800/47000-47500/48000 in the coming days; otherwise sustaining below 45450/45200, DJ-30 may again fall to 45000/44750-44650/44200, DJ-30 may again fall to 43900/43300-42600/41600 in the coming days.

Similarly, NQ-100 Future (21450) has to sustain over 21200 for a further boost to 21500 and further to 21700/21900-22050/22500 and even 21450 levels in the coming days; otherwise, sustaining below 21150, NQ-100 may again fall to 20950/20850-20500/20300 and 20000/19800-19650/19350 in the coming days.

Technically, SPX-500 (CMP: 6050), now has to sustain over 6100 for any further rally to 6150/6200-6350/6500 in the coming days; otherwise, sustaining below 6075/6050 may again fall to 6000/5950-5900/5850 and 5675/5600-5550/5500 in the coming days.

Also, technically Gold (CMP: 2650) has to sustain over 2680 for a recovery to 2700-2725 and further 2735/2750-2775/2795 and 2815 in the coming days; otherwise sustaining below 2655-2630 may again fall to 2605/2600 and 2590/2565 and further fall to 2550/2500-2470/2450 in the coming days (depending upon Fed rate cuts, Gaza/Ukraine war trajectory); Gold surged almost 75% in the last one year since Gaza war started back in October’23. Now it may retrace to $2100 levels if Trump indeed can mediate both Gaza and Ukraine war ceasefire by early 2025.