USD slumped on Trumpcession panic despite hot core PCE data

·       ·       Gold surged despite stalled core disinflation, hawkish Fed, fading hopes of two Fed rate cuts in 2025, and progress of Gaza & Ukraine war ceasefire

·       Trump's trade war tantrum may be pushing the US economy into stagflation and the risk of a sovereign downgrade

·       Wall Street is now in full control of Trump, his morning mood, Truths, random comments, and policies; economic data, Fed, and monetary policies are now on the backburner

On Friday, March 28, 2025, Wall Street Futures tumbled on Trump’s trade war uncertainty as the so-called US Liberation Day 2nd April is approaching fast for the imposition of Reciprocal tariffs to return for the Golden Age of America. Also, stalled US core disinflation, surging US inflation expectations, and plunging US consumer confidence dragged Wall Street for potential stagflation or even Trumpcession. Although the report for EU concessions briefly helped stocks, it was short-lived as Trump reiterated about auto and reciprocal tariffs in his public comments.

The US core disinflation almost stalled even before potential Trump tariffs.

On Friday, apart from the ongoing Trump trade war tantrum, some focus of the market was also on U.S. Core PCE inflation, the Fed’s preferred gauze to measure underlying inflation trends. The BEA flash data shows U.S. annual (y/y) core PCE inflation (Seasonally Adjusted-SA) increased by 2.8% in February’25, edged up from 2.7% sequentially, above the market expectations of +2.7% and highest in a year. The Fed’s target core PCE inflation is around +1.5% and core CPI inflation is 2.3% on a sustainable basis, the average of which is +1.9% and just below +2.0% core inflation targets.

Although the US core PCE inflation for February’25 comes at 2.8% against median market expectations of 2.7%, on the 19th March, Fed meeting, Chair Powell estimated it is at 2.8% as par US core PCI and PPI data. Thus the overall surprising factor of the market is quite brief after the initial knee-jerk reaction in Gold, USD and Wall Street Futures.

On a sequential (m/m) basis (seasonally adjusted) the U.S. core PCE inflation increased by 0.4% in February’25 against +0.3% in the prior month, above the market expectations of 0.3% and the highest since January’24.

Overall, after the latest revisions, the 2024 average core PCE inflation was around 2.8%, while the 3MRA is also around 2.8%. The US core PCE inflation needs to go around 1.5% from present levels of 2.8%; i.e. almost around 130 bps for the Fed’s price stability target of core inflation of 2.0% on a sustainable basis.

On Friday, the BEA flash data showed U.S. annual (y/y) total PCE inflation (Seasonally Adjusted-SA) increased by 2.5% in February’25 against 2.5% sequentially (unchanged), and in line with the market expectations of 2.5%. But it’s still far above 1.5% pre-COVID (Dec’19) average levels or actual targets of the Fed, equivalent to total CPI around +2.3%.

On a sequential (m/m) basis (seasonally adjusted) the U.S. total PCE inflation was increased by 0.3% in February’25 against 0.3% in the prior month (unchanged) and in line with the market expectations of 0.3%.

Overall, after the latest revisions, the 2024 average PCE inflation was around 2.5%, while the 3MRA is around 2.6%. The US PCE inflation needs to fall around 1.5% from present levels of 2.5%; i.e. almost 100 bps for the Fed’s price stability target of 2.0% inflation in a sustainable way.

In February’25, the so-called U.S. super core PCE inflation (w/o food, energy, and housing), the current focus of the Fed, edged up to +2.5% from 2.3% (y/y). The US super core PCE inflation was around +1.4% in pre-COVID days (Dec’19). The sequential (m/m) US super core PCE inflation surge was unusually higher at 0.4% in February’25.

Overall, after the latest revisions, the 2024 average super core PCE inflation was around 2.3%, while the 3MRA is around 2.4%. The US super core PCE inflation needs to fall around 1.2% from present levels of 2.4%; i.e. almost 120 bps for the Fed’s price stability target of 2.0% inflation in a sustainable way.

The 3MRA of US core inflation (PCE+CPI) is now 3.0% vs the Fed target of 2.0%

The Fed usually goes by a 3M rolling average of core inflation (PCE+CPI) for any important policy move.  The 3MRA of average core inflation is now around 3.0%, while the unemployment rate is 4.1% against the target of 2.0% and 3.5% respectively. Usually, the Fed considers 4.0% average levels (orange line) as minimum unemployment; i.e. maximum employment (96% of the available work/labor force), sustainable in the longer run. But the Fed also considers a 3.5% unemployment rate as the minimum (green line), below which there may be a risk of inflation while a 4.5% unemployment rate may be a red line for the Fed, above which there would be a risk of an all-out economic slowdown (hard landing) or even a recession (if sustained over a few months).

As the Fed now needs to bring down average core inflation by around 100 bps to 2.0% and the unemployment rate by 60 bps to 3.5%, it’s maintaining that both sides of the dual mandate are in balance. In 2025-26, the Fed will try to bring down core inflation towards 2.0% from present levels of 3.0% by keeping the unemployment rate at least around 4.0%; thus Fed may cut only 50 bps each in 2025-26 against 100 bps in late 2024.

In brief, for the achievement of dual mandate (minimum price stability and maximum employment), the Fed now needs to bring down average core inflation (PCE+CPI) to around 2.0% from the present levels of +3.0% without allowing the average unemployment rate materially above 4.5%. If the unemployment rate surges above 4.5%, then the Fed may go for a more rapid dialing back of the restrictive rate (deeper rate cuts with a complete haul to the QT), while 3.5% unemployment levels would be consistent with 2.0% core inflation price stability targets and 3.00-2.75% longer-term Fed terminal/neutral rate.

Although the Fed targets +2.0% core PCE inflation officially as a price stability target, in reality, usually it’s +1.5% on average due to a 0.5% lower spread with core CPI inflation. Fed's price stability target is just below 2.0% inflation on a durable basis. The Fed generally targets average core inflation (PCE+CPI) +1.9%-as core PCE inflation is generally -0.5% lower than core CPI. In reality, the Fed targets 1.5% core PCE and 2.3% core CPI for average core inflation at around +1.9%, but may never publicly acknowledge it to suit its narrative and change of goal posts as per evolving economic situations or financial conditions.

Thus Fed's average targets for the Fed’s dual mandate for 2025-27

·       Average Core inflation (PCE+CPI) target 2.0%; vs current 3MRA 3.0%

·       Unemployment targets 3.5% (green line); vs current 3MRA 4.1%

Post-COVID, the Fed may maintain a real positive rate between 1.00-2.00% as per underlying economic conditions; for 2025, as core disinflation almost stalled after H2CY24, the Fed may prefer to maintain an average real interest rate around +1.50% against +1.00% in 2023 (wrt to average core CPI inflation), when there was good pace of core disinflation amid post-COVID supply chain restoration and higher supply of labor force/immigrants (no COVID related restrictions).

Modified Taylor rule suggests 50 bps cumulative Fed rate cuts in 2025

As per Taylor’s modified rule, considering the desired real REPO rate of +1.50% in 2025, the average core CPI inflation for 2024 is around 3.10% vs target of 2.00%; the average unemployment rate is 4.0% vs longer-term target of 3.50%; average real GDP growth +2.90% vs potential/target 3.00% (considering increasing population/immigrants w/o Trump policy), Fed REPO rate should be around 4.00% by Dec’25 against 4.50% in Dec’24; i.e. Fed should cut by cumulative 50 bps in 2025.

The US has to increase the supply capacity of the economy for durable price stability.

Although the Fed targets core PCE and core CPI inflation, in the longer run, it ensures both core and total PCE and CPI inflation are around 1.5% and 2.3% respectively, averaging a 2% inflation mandate by the US Congress. Fed needs to ensure 2% price stability on a sustainable basis in the medium to longer run as the price stability target.

The general US public is now extremely unhappy about elevated price levels, almost 25% higher than pre-COVID days; people are more concerned about the higher cost of living or higher prices of even day-to-day goods & services rather than the rate of increase (inflation). The US government of the day also needs to ensure proper policies are in place for a smooth global supply chain from a low-cost, but efficient manufacturing hub like China, without which most ordinary Americans just can’t survive.

Also the US, at present needs to develop a huge industrial and logistical ecosystem to compete with mighty China, the world’s number one factory house, which may not be possible instantly. The US needs to increase the supply capacity of the economy, including housing and also other social and traditional/transport infra to match increasing demand amid increasing immigrants/population and price stability. Fed can’t control demand and manage inflation forever with its monetary policy through adjustments of interest rates and money supply.

The US is a country of global immigration, which also helps it into a major innovator and service-oriented economy. Also, semi-skilled/unskilled immigrants from South America, South Africa, South Asia, and other poorer countries are essential for low-skilled jobs like hotels & restaurants, farming, agriculture, etc. If Trump indeed doubles down on his immigration policies and causes huge deportations of around 10/11M so-called illegal immigrants in the country, it may cause a severe labor shortage, resulting in a tighter labor market and higher wage/normal inflation.

Difference between CPI and PCE inflation in the US:

In the US, Core CPI (Consumer Price Index) and Core PCE (Personal Consumption Expenditures) are two different measures of inflation used to gauge price changes in the economy as well as any change in consumer consumption behavior after any meaningful change of prices (excluding food and energy prices due to their volatility).

The key differences between US Core CPI and Core PCE inflation are:

·       Core CPI measures the change in the prices of a fixed basket of goods and services purchased by households (out of pocket), while Core PCE measures the change in prices of variable goods and services consumed by individuals (both excluding food and energy).

·       Core CPI focuses on the price changes of a fixed basket of goods and services typically consumed by urban households, while Core PCE has a broader scope, including all goods and services consumed by households, and adjusts for changes in consumer behavior in line with any significant price changes (e.g., substitution effects).

·       The Core PCE, on the other hand, includes a broader range of expenditures. It accounts not only for out-of-pocket expenses but also for various goods and services paid for by third parties, such as employer-provided health insurance. This means that the PCE captures a wider array of consumer spending and includes expenditures by non-profit institutions as well.

·       The CPI uses a specific formula, which is based on a fixed basket of goods. This means it does not adjust for changes in consumer behavior in response to price changes. For example, if the price of beef rises, the CPI does not account for consumers switching to chicken.

·       The PCE employs a Fisher ideal index formula, which allows for substitutions between items as their relative prices change. This flexibility typically results in a smoother inflation rate, as it reflects changing consumer preferences more accurately. For example, if the price of beef rises, the CPI does not account for consumers switching to chicken, but the PCE does

·       The weights assigned to different categories in the CPI are based on a fixed survey of consumer spending patterns. These weights are updated less frequently, which can lead to discrepancies over time as consumer behavior shifts.

·       The PCE updates its weights more regularly based on current expenditure data, reflecting more recent consumer spending habits. This results in a more dynamic representation of inflation as it adapts to changes in consumption patterns.

·       Historically, the Core CPI tends to report higher inflation rates compared to the Core PCE. For instance, since 2000, the average annual PCE inflation has been about 0.5% points lower than that of the CPI. This difference can be attributed to the broader scope and more adaptive nature of the PCE, which captures the effects of consumer substitution more effectively.

·       Both the Core CPI and Core PCE are essential for understanding underlying inflation trends in the U.S. economy.

·       The Fed prefers Core PCE because it provides a more comprehensive view of inflation and better captures changes in consumer behavior.

·       As price stability, the Fed eventually tries to converge both core and total inflation to the same levels; i.e. both core CPI and total CPI around +2.3%,  and core PCE and total PCE inflation +1.5% for a longer run.

Primary reasons behind stalled core disinflation in the US

The average rate of core disinflation was around -0.2% per month in 2023, which is now reduced to -0.1% per month in 2024. In 2023, the rapid pace of disinflation was due to the easing of the supply chain/constraints and also the supply of more workers/labor force amid huge immigration (legal/illegal). But the main effect of those easing in the supply chain (goods & labor/service) may be already over by 2023 (after withdrawal of all types of COVID restriction by late 2022) and thus we are now seeing comparatively slow, but predictable disinflation, although often stalled.

Goods inflation is also again ticking up in the US amid higher demand from increasing population/immigration; also demand for housing, especially rented homes is high, resulting in elevated rent/housing inflation. This along with increasing geopolitical and global trade/supply chain fragmentation, the US disinflation almost stalled in late 2024. Also, there was a scramble to buy various goods from Americans ahead of a potential rate increase as a result of the Trump trade war tantrum, which is also boosting inflation, especially in early 2025.

Fed is now preparing the market for only one or two rate cuts in 2025

At present trend, the US core CPI inflation may come down to around 2.3-2.0% on a sustainable basis by mid-2027. Thus Fed is now cautious about stalled core disinflation and wants to reduce the restrictive rate in an orderly manner or cautiously with a 50 bps cumulative cut each in 2025-27 rather than 100 bps in 2025-26. Fed already cut 100 bps in advance (front loading) in H2CY24 to ensure no hard landing after some unusual uptick in headline unemployment rate mid-2024. Fed may have gone for the panic cut of 50 bps in September ’24 and 25 bps each in November and December’24 in anticipation of the Trump trade war and policy tantrum 2.0. Thus Fed may now afford to wait & watch.

On Friday, Fed’s Daly said:

·       Stagflation is a tail risk, we can't rule it out, but I have not heard about it from contacts

·       I am 100% focused on inflation, progress has been flat

·       Friday's inflation data confirms my own decreased confidence in my modal outlook

·       We need a wait-and-see posture on monetary policy, give industries time to adjust to tariffs

·       Policy is in a good place, have to be patient to ensure inflation comes down

·       Two rate cuts are still a reasonable projection for 2025

·       Growth and labor market remain solid

·       We are making sure we are on a sustainable path to 2% inflation is top of mind

·       I'm hearing cautious optimism from businesses

·       I have not changed her rate-path projection since last year, doesn't have enough info to make a change

·       Two rate cuts still reasonable for 2025

On Friday, Fed’s Barkin said:

·       Companies will face a tough decision between raising prices and losing volume or not raising prices and getting margins squeezed

·       My instinct on auto tariffs is that the top line number will not be the increase that is faced by consumers given the competition.

·       Dampened business demand would most likely be seen in capital spending and hiring.

·       Auto companies to face hurdles passing tariffs to consumers, with competition in market-relative prices crucial

·       Companies may find themselves with less pricing power than they might have anticipated.

·       To analyze the claim that tariffs would result in a one-time change in price level, but will monitor closely for reactions from businesses and consumers

·       The inflation risk of tariffs is clear, but labor market risk is likely if firms need to reduce costs.

·       Less Confident Lowered Sentiment Will Impact Consumer Spending, Not Yet Seeing it in Credit Card Data.

·       Tariffs Not Expected to Have Only Temporary Effect on Prices

·       Inflation Expectations Loosen, Not De-Anchored

·       Warned not to assume just a one-time change in prices from tariffs

Conclusions:

Fed sees stagflation as it projects lower economic (GDP) growth, higher inflation, and a higher unemployment rate for 2025. Fed Holds Rates as unanimously expected; signalled further tapering of QT and virtually blamed Trump policy uncertainty for the stagflationary US economic outlook.

On March 19, 2025, Fed presser, Chair Powell sounded less hawkish on Trump tariffs and the Trumpflation narrative. Powell was cautious in his assessment of how President Trump's trade war might shape the economy, citing the possibility that tariffs' impact on consumer prices would be ‘transitory’. Overall, Powell played safe and avoided a direct head-on collision with Trump on fiscal policy issues.

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, US 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 needs to bring down average core inflation by around 100 bps to reach the target along with the unemployment rate by around 0.5% by mid-2027 to declare victory.

Fed already cut 100 bps in late 2024 (September-December), anticipating Trump 2.0 and policy uncertainty. Fed may have cut 50 bps in September 2024 in an unusual panic mode after Trump’s election-winning probability started beginning to surge and beat Harris by July amid two consecutive ‘assassination attempts’ on his life. Thus Fed now has the policy space and time to wait & watch till at least H1CY25.

Bottom line

Fed may cut in June and December’25 @25 bps each to be ahead of any potential Trumpcession curve.

Impact on USD:

Normally, the combination of hotter-than-expected US core inflation data, less hawkish Fed talks, fading hopes for two rate cuts in 2025 and Trump trade war tantrum is positive for USD (as a trade war currency). But despite that USD stumbled after December’24 as the Trump trade war may cause stagflation or even an all-out Trumpcession. Also, there are some probabilities that the US sovereign rating may be downgraded in the coming days by big global rating agencies like Moody’s, Fitch and S&P due to the never-ending US debt limit and shutdown saga. Gold is getting a boost and making new life time highs almost every other day on Trumpcession and Trumpflation concerns despite the progress of the Ukraine and Gaza war ceasefire and no big probability of another war in the Middle East between Iran and Israel/US.

Weekly-Technical View: USDJPY, EURUSD, GBPUSD and Gold

Looking ahead, whatever the fundamental narrative, technically USDJPY (CMP: 149.75), now has to sustain over 152.00 for a further rally towards 152.50/153.00-154.25/156.75 and 160.00/162.50-163.00/164.75 in the coming days. On the flip side, sustaining below 151.60/151.00-150.00/149.50, it may again fall towards 149.00/148.50-148.00/146.50 and 144.75/143.50-143.00/141.40 and 139.50/139.00=137.00/131.75 in the coming days.

Looking ahead, whatever the fundamental narrative, technically EURUSD (CMP: 1.08200) now has to sustain over 1.09000 for a further rally towards 1.10700/1.12100-1.12700/1.14000 and further 1.15000/1.15400/1.16000-1.20700 in the coming days. On the flip side, sustaining below 1.08500, EURUSD may again fall to 1.08000/1.07300-1.06900/1.1.06500 and 1.05700/1.05000 and further 1.04000/103500-1.02500/1.01700 in the coming days.

Looking ahead, whatever the fundamental narrative, technically GBPUSD (CMP: 1.29400) now has to sustain over 1.30500 for a further rally towards 1.31400/1.33600-1.34400/1.34800 and further 1.35500/1.37100 and 1.38400/1.39700 in the coming days. On the flip side, sustaining below 1.30000, GBPUSD may again fall to 1.30000/1.29200-1.28400/1.27500 and 1.26600/1.25900-1.24300/1.2390001.20700/1.20000 in the coming days.

Also, technically Gold (CMP: 3085) has to sustain over 3105 for a further rally to 3125/3150-3200/3225; otherwise sustaining below 3100-3095, Gold may again fall to 3065-3065/3045-3025/2990, and further 2965/2925-2900/2880 and 2850/2835-2810/2780-2780 and 2745/2725-2695/2665 and further 2635/2600-2585/2560 in the coming days.