US bonds and stocks stumbled on hawkish talks by Fed Powell

On Wednesday, Wall Street was almost flat on fading hopes of an early Fed rate cut in 2024 and lingering suspense about the Gaza war tactical pause/ceasefire. But Gold and oil slid on ease of Gaza war tensions amid fading concern of a wider regional conflict involving Iran. Despite lingering suspense about humanitarian pauses in the Gaza war and categorical denial by Israel's PM about any form of ceasefire or even a pause, the market was expecting such a tactical pause as the CIA director continues in talks for a temporary pause in exchange for captives for several days in the Middle East. The CIA director William Burns has been travelling in the Middle East for the past several days.

Last weekend, Burns went first to Israel, then to Egypt, and now to Qatar, a country that has played a key role in negotiating the release of captives held in Gaza. The talks appeared to center on the idea of a three-day pause in attacks in return for the release of 10-15 captives; the talks seem to be gaining momentum. Burns spent much of his long career as a seasoned diplomat in the Middle East and is well-known/have good relation with the leaders in that region.

On Thursday, NATO chief Stoltenberg said allies back Gaza humanitarian pauses in the war to allow aid to reach Gaza amid the worsening humanitarian crisis as international law must be respected and civilians must be protected. He also warned against the conflict spilling out into a regional war: “The war in Gaza must not turn into a major regional conflict. Iran and Hezbollah must stay out of this fight.”

On early U.S. Session Thursday, Wall Street Futures slipped, while Gold and silver got some boost after a report that a rocket had landed in Eliat City in southern Israel (without any warning siren); although the source of the rocket was not immediately known; it was suspected by Yemen’s Houthi rebels who claimed the rocket attack on Eliat and warned that more strikes would follow until the Israeli aggression stops and Palestinians are victorious.

Finally, the White House (rather than Israel) announced that Israel has agreed to suspend fighting for four hours daily to allow Palestinian civilians to flee from northern Gaza. The White House national security spokesperson Kirby said the pauses would allow people to flee from the north to south along two humanitarian corridors. He said Israel would announce the pauses three hours in advance. Kirby further clarified that there will be two “humanitarian corridors” for people to flee from northern Gaza and that Israel has said that there will be no military operations in those areas during those periods. Kirby said that the White House believed that the pauses were a step in the right direction, and want them to continue for as long as they are needed. The U.S. aims for no less than 150 humanitarian trucks a day into Gaza.

Israel quickly moved to say the pauses did not represent a ceasefire; Military spokesman Hecht called them “tactical, local pauses for humanitarian aid”, while Defence Minister Gallant described them as “localized, pinpoint measures”. Israel also clarified that such tactical/humanitarian pauses in fighting are not new, saying they had been conducting them for the last few days.

A statement from Israel's PMO has no mention of the four-hour humanitarian pauses the White House announced, and instead pushes the narrative that Israeli forces are already pausing fighting for several hours a day to allow civilians to travel south: “The fighting is continuing and their will be no ceasefire without the release of our captives. Israel is enabling safe corridors from the Strip’s north to its south, as 50,000 (Palestinians in Gaza) did only yesterday.”

But various humanitarian groups have said the 4-hour pauses are inadequate and have repeated calls for a wider ceasefire and for more aid to be able to access the bombarded enclave. A well-known Middle East expert said: “Pauses are not a solution---what is needed is a ceasefire so that humanitarian aid can come in uninterrupted, that foreigners can leave the country, and maybe negotiations can take place. If this is only a pause to allow people to move from the North to the South, it did not work in the past, it will not work in the future. In four hours, people cannot come. They don’t have cars, they don’t have fuel. It’s not going to work. There is mounting pressure on Israel now to open up for a real ceasefire, a real truce for a day or two or three. I think that is coming in the next few days”.

U.S. President Joe Biden told reporters he was still pushing for longer pauses in Gaza to get captives released. But Biden’s request for a longer humanitarian pause was rejected by the Israeli PM. US President Joe Biden says his request for a humanitarian pause lasting up to three days instead of only a few hours was rejected by Israeli PM Netanyahu. Biden said: “I asked for longer pauses. The longer pause was meant to help facilitate the release of Israeli captives in Gaza”.

Overall, both Israel and the U.S. are under pressure globally and locally for the current stance of using excessive force without caring for the hostages/captives, even after considering the self-right of Israel to eliminate Hamas to ensure durable peace and safety for its citizens. Middle East U.S. Diplomats are divided about U.S. policy for the Israel-Hamas/Gaza war, but they are also maintaining that till now, there are no signs of Iran or its proxies seeking escalation despite the exchange of fire between Israel and Hezbollah across the border with Lebanon: “We do not believe that a conflict involving Lebanon and Israel is in any way inevitable. The here-and-now reality is there is no indication on any side that there is an intent to precipitate a conflict or a war.”

On Thursday Fed’s Goolsbee said:

·         Fed will need to monitor risks of overshooting on rates

·         Higher long-term yields can have a substantial effect if sustained

·         The Fed will need to watch for risks of overshooting on rates

On Thursday Fed’s Harker said:

·         FOMC will stay higher for longer, no sign of near-term rate cuts

·         Rates should stay high as the inflation fight goes on

·         We are confident that consumers will help achieve a soft landing

·         The next Fed rate choice 'could go either way' depending on the data

·         The labor market is moving into a better balance

·         No recession can be seen, though growth is likely to cool off

·         The Fed will stay higher for longer; there is no sign of near-term rate cuts

·         I supported the steady interest rate stance at the latest FOMC meeting

·         The unemployment rate is to rise to 4.5% in 2024 before falling

·         Inflation is steadily falling and is to hit 3% in 2024, 2% after

·         It's unclear yet whether consumers have expanded their spending power

·         Now is a time to take stock of past rate hikes’ impact

On Thursday, Fed’s Barkin said:

·         We are still not seeing the full effects of rate hikes

·         The policy is likely sufficiently restrictive

·         I believe a slowdown is coming, which is needed to lower inflation

·         Anecdotal evidence at odds with the latest GDP report

·         There is a wide range of potential outcomes for the economy

On Thursday, Fed’s Powell clarified that the Fed is still not fully convinced rates are sufficiently high. Powell stated that it is too early for the central bank to definitively announce the end of its significant interest-rate hikes over the last two years: “The Federal Open Market Committee is committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation down to 2 percent over time; we are not confident that we have achieved such a stance”.

Powell said in a prepared text at "Monetary Policy Challenges in a Global Economy" -hosted by the IMF:

“U.S. inflation has come down over the past year but remains well above our 2 percent target. My colleagues and I are gratified by this progress but expect that the process of getting inflation sustainably down to 2 percent has a long way to go. The labor market remains tight, although improvements in labor supply and a gradual easing in demand continue to move it into a better balance. Gross domestic product growth in the third quarter was quite strong, but, like most forecasters, we expect growth to moderate in coming quarters.  Of course, that remains to be seen, and we are attentive to the risk that stronger growth could undermine further progress in restoring balance to the labor market and in bringing inflation down, which could warrant a response from monetary policy.

The Federal Open Market Committee (FOMC) is committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation down to 2 percent over time; we are not confident that we have achieved such a stance. We know that ongoing progress toward our 2 percent goal is not assured: Inflation has given us a few head fakes. If it becomes appropriate to tighten policy further, we will not hesitate to do so.

We will continue to move carefully, however, allowing us to address both the risk of being misled by a few good months of data and the risk of overtightening. We are making decisions meeting by meeting, based on the totality of the incoming data and their implications for the outlook for economic activity and inflation, as well as the balance of risks, determining the extent of additional policy firming that may be appropriate to return inflation to 2 percent over time. We will keep at it until the job is done.”

Highlights of Powell's speech and Q&A:

·         High inflation is primarily caused by COVID-related supply disruptions, especially after 2nd wave and COVID-related huge fiscal stimulus/grants (positive for household demand) coupled with the subsequent Russia-Ukraine war from Feb’22; Fed goes for liftoff from Mar’22

·         Now the the unwinding of pandemic-related supply and demand distortions is playing an important role in the decline of inflation. For example, wage growth has steadily fallen by most measures since mid-2022, despite continued robust job gains, reflecting a resurgence in labor supply thanks to higher labor force participation and a return of immigration to pre-pandemic levels

·         While the broader supply recovery continues, it is not clear how much more will be achieved by additional supply-side improvements. Going forward, it may be that a greater share of the progress in reducing inflation will have to come from tight monetary policy restraining the growth of aggregate demand

·         Today, inflation and policy rates are elevated, and the ELB (Effective Lower Bund) is not currently relevant to our policy decisions. But it is too soon to say whether the monetary policy challenges of the ELB will ultimately turn out to be a thing of the past

·         Monetary policy generally works in ways that the Fed expected, though some aspects are different

·         The US economy has been stronger than expected, this year remarkable

·         We probably have a significantly restrictive policy

·         The Fed is in the range of restrictive policy, the question of whether the neutral rate has risen is less interesting

·         The bigger mistake remains not getting rates high enough

·         The Fed is still trying to judge if it needs to do more, then we will consider how long to keep rates high

·         We're looking carefully at the reasons behind the recent yield surge

·         The Fed is not going to ignore a significant bond tightening but does not have to make a decision now

·         It's hard to draw a direct line from things like higher bond yields to a monetary policy response

·         Some households and businesses are not feeling higher rates

·         Monetary policy generally works in ways that the Fed expected, though some aspects are different

Conclusion:

On Thursday, Powell didn’t say anything new, which the market does not know. The Fed will be on hold with a hawkish stance in December too and hold the same at least till Sep’24; the Fed tightening cycle is now almost over (if there is no abnormal surge in core inflation in the coming months).

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 Thursday, apart from the ongoing Gaza war, some focus of the market was also on Fed Chair Powell’s IMF speech, which turned out more hawkish than expected. This, along with a terrible US30Y bond auction (lower demand/few bidders for $24B TSY auction/US debt), US bond yield to surge again. Subsequently Wall Street Futures, Gold, and Silver stumbled despite a 4-hour daily humanitarian pause in the Gaza war and the increasing possibility of a 3-day ceasefire for the release of some hostages.

On Thursday, blue-chip DJ-30 slumped almost -400 points from the session high and closed -220 points lower, while broader SPX-500 tumbled -0.90% and tech-heavy NQ-100 lost -0.80%. Wall Street was dragged by all 11 major sectors led by healthcare, consumer discretionary, real estate, utilities, materials, banks & financials, consumer staples, techs, communication services, energy (lower oil), and industrials. Boeing and Walt Disney helped Dow-30 to some extent amid upbeat report cards. China’s deflation is like CPI data, but positive core inflation readings have a mixed impact on Wall Street as PBOC may cut rates, while we may see more targeted fiscal stimulus in the coming days.

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

Whatever the narrative, technically Dow Future (34150), now has to sustain over 34300 for any further rally to 34500/34650 and 34855 and further to 35375-35875 in the coming days (if there is a Gaza ceasefire/Israel ends its intensifying surgical/military operation).; on the other side, sustaining below 34250, Dow Future may again fall to 33950/33650-33450/33150 and 32950/32650-32300/32200 and 32000/31750-31595/31190 and even 29400-28475 levels (in case of a wider major regional military conflict).

Similarly, NQ-100 Future (15222), now has to sustain over 15350-15550 for any further rally to 15625/15750-15975/16075 in the coming days; otherwise sustaining below 15300, NQ-100 may again fall to 15100/15000 and 14800/14600-14450/14300-14200/14100 and 14000/13800-13650/13500-13395/12990 and 12790/12400-12180/11650 and even 11000-10675 in the coming days. (under the worst scenario of Gaza regional war).