Santa rally continues in Dow on hopes of an early Fed cut

On Monday, Wall Street (US stocks) was boosted, while Gold slid by hopes of an early end of the Gaza War, and softer than expected 1Y inflation expectorations; but Gold also recovered to some extent after stronger than expected US bond auction. Wall Street Futures were also buoyed by hopes of a blockbuster stimulus from China to boost the economy from its present slumber, mainly caused by subdued external trade/export and a domestic property developer/sub-prime housing loan crisis.

China said:

·         Will consolidate and enhance economic recovery in 2024

·         Will vigorously promote new industrialization, develop the digital economy, and accelerate the development of AI

·         Will implement structural tax and fee reduction policies and enhance fiscal sustainability

·         China's CEWC: The economy is recovering and improving

·         It's necessary to overcome some difficulties and challenges in promoting an economic rebound

·         Will "establish first before demolishing" and "facilitate stability through progress" for economic work next year

·         China confirmed that it held its annual Central Economic Work Conference (CEWC) this week

·         China held its annual central economic work conference from December 11-12

In the early Tuesday Asian session, Wall Street Futures were buoyed by hopes of stimulus and targeted structural reform by China, the world’s 2nd largest economy and US MNC’s biggest external consumption market. Most of the big MNCs in the U.S. and Europe are now quite dependent on China’s consumption. In reality, despite the never-ending narrative of the Cold War between the U.S. and China, both are dependent on each other for prosperity and growth.

Further, in the early European session, the USD got some boost after a subdued payroll/job report from the U.K. (as GBPUSD slips); subsequently, Wall Street Futures, especially export-savvy U.S. MNCs slip to some extent (as stronger USD is generally negative for their export income).

In any way, Wall Street Futures were also buoyed, while Gold undercuts on hopes of an early ceasefire of the Gaza war. For the last few days, intensifying Gaza war is not affecting Wall Street or even boosted Gold, because the war may be very close to the end, most probably before X-Mas by 24th December, so that both the US, Israel, Europe and also Palestine can have a ‘peaceful celebration’. There is now huge pressure on Israel and also U.S. for a permanent ceasefire as 80% of Gaza City is now almost destroyed, comparable to the destruction in WW-II days.

On Tuesday, US President Biden criticized Israel’s relentless bombing campaign: “They’re starting to lose that support--- This is the most conservative government in Israel’s history---the Israeli government doesn’t want a two-state solution”.

On Tuesday, apart from the ongoing Gaza war trajectory, all focus of the market was also on U.S. core CPI inflation for November 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) was unchanged at +4.0% in November from +4.0% sequentially, in line with the market consensus of +4.0% and the lowest since Sep’21. In Nov’22, the annual core CPI was +6.0%, and +5.6% in Jan’23; i.e., the core CPI has reduced by almost -2.30% in the last 10 months.

The U.S. Core service inflation (w/o energy service) is also unchanged at +5.5% in November from +5.7% in September 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 Nov’23, the shelter index, accounting for over 70% of the total increase in all items less food and energy, eased to 6.5% in November from 6.7% in the prior month. Other indexes with slower increases over the last year include recreation (+2.5% vs +3.2%), personal care (+5.2% vs +6%), and new vehicles (+1.3% vs +1.9), while prices of motor vehicle insurance remained elevated (+19.2%, the same pace as in October).

On Tuesday, the BLS data showed the sequential (m/m) US core CPI (seasonally adjusted) rose +0.3% in November from +0.2% sequentially, in line with market expectations of +0.3% advance. In Nov’23, consumer prices accelerated for services excluding energy services (0.5% vs 0.3% in October), amid faster increases in the shelter (0.4% vs 0.3%), transportation services (1.1% vs 0.8%), and medical care services (0.6% vs 0.3%). Among goods, the CPI rebounded for used cars and trucks (1.6% vs -0.8%) to record its first increase since May, while the prices fell for new vehicles (-0.1% vs -0.1%) and apparel (-1.3% vs 0.1%).

Overall, the YTM average of US core CPI is now around +4.9% in 2023 against +6.15% in 2022, while the 6M rolling average is around +4.3%. At the current trend, U.S. core PCE inflation (at 2012 constant prices) should be around +3.7% in November (against +4.0% core CPI).

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 +3.00%, 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 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. Also, the Fed will take into account a 6M rolling average of core CPI for any policy decision rather than one month. But the Fed may also note that core CPI stalled at +4.0% in October and November in contrast to the last 4-month’s continued decrease. In a way, the market is now expecting the first Fed rate cut in May’24 rather than Mar’24.

On Tuesday, the U.S. Treasury Secretary Yellen said after the core CPI data:

·         Prices are rising at a much slower rate than before, but the level of prices, including rents, are still higher

·         It is not necessary to have high unemployment to lower inflation

·         The US economy is on the path to a soft landing

·         Rising real rates may impact the Fed's decision on the rate path

·         There's no evidence that inflation is becoming ingrained, or that there is a wage-price spiral

·         Inflation expectations are well under control

·         There's no reason to believe that the last mile will be especially difficult

·         Wage increases continue at a healthy pace

·         The labor market remains strong but is cooling

·         I see no reason why inflation shouldn't come down to the Fed's target

·         Inflation is coming down meaningfully

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

Whatever may be the narrative, technically Dow Future (36621), now has to sustain over 36900 levels for a further rally to 37050/37150-37350/37500 levels in the coming days; otherwise, sustaining below 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 (16390) now has to sustain over 16300 for a further rally to 16750-16800 zones; otherwise sustaining below 16250, may fall to 16100/16050-15700/15400, and further 15100-14140 in the coming days.

Also, technically Gold (XAU/USD: 1981) now has to sustain over 1975-1995 for any recovery to 2010/2015-2035/2045 and further rally to 2065/2075-2130/2150 areas.; otherwise sustaining below 1970, may fall to 1960/1950 and 1928/1908-1895/1885 and 1850/1810 in the coming days.