Wall Street Futures, Gold recovered on QT tantrum panic low

Wall Street Futures and gold soared last Thursday on hopes & hypes of an early Fed pivot/put. The market was expecting -100 bps Fed rate cuts in 2024 and 2025 each (from June 24) and QT tapering from June’24 to close the same by Dec’24. But going by the overall Fed/Powell/Waller statements, Q&A comments, trend of core inflation, labor market condition, and also the Nov’24 US Presidential Election, the Fed may go for -75 bps rate cuts in 2024 starting from September’24. Previously, the market was anticipating Fed rate cuts from June’24. The CME Fed swaps now price in only -75 basis rate cuts in 2024 against earlier -150 bps a few months ago. Also, Fed swaps now gradually implying no rate cut in June’24.

Looking ahead the focus of the Fed/market may be now QT trajectory and minimum/optimum size of the Fed’s balance sheet or bank reserves for ample liquidity for the smooth operation US money/funding market so that the episode of late 2019 QT/REPO market tantrum can be avoided. Fed may announce a plan for QT tapering/closing in the May meeting and should close the same before going for rate cuts from Sep’24.

Ideally, the Fed, the world’s most important/credible (?) central bank may not continue QT (even at a reduced pace) and go for rate cuts at the same time as QT, and rate cuts are contradictory, although Fed/Powell kept the option open, at least theoretically. Ideally, the Fed may not taper the QT and continue the present pace of -0.095T/M for the next 6 months (April to mid-Sep 24) to reduce the size of the B/S from the present $7.50T (at March’24 end) to around $6.95T (almost 23% of projected CY24 nominal GDP $30.00T) before going for rate cut cycle from 18th September’24. Fed may like to keep its B/S size just above ‘ample’ levels and by ample levels, Fed may consider $6.00T as the ‘minimum base’ which would be around 20% of the projected US nominal GDP of $30.00T.

But on Good Friday, in an economic conclave (SF Fed/Daly), Fed Chair Powell indicated a lower B/S size than $6.95T, which the Fed is planning through prolonged QT at a slower pace (QT tapering) to avoid any late 2019 like repo market disruption. Thus assuming an absurd/bizarre phenomenon, the Fed may go for -75 bps rate cuts in H2CY24, most probably from Sep’24 after deciding about the possible B/S size/QT trajectory/tapering in the May meeting to ensure money/funding market stability. Remember, QT is a new experiment for the Fed, which had previously failed in late 2019 as the Fed miscalculated the minimum/optimal amount of required bank reserves around $1.5T.

Fed’s B/S size is now around $7.50T (March 24), reduced from around $8.96T life time high scaled in Apr’22. Fed is doing QT from June’22 with a pace of $0.048T/M till Aug’23 and presently at a higher pace of 0.095T/M from Sep’23 (after ending the rate hike cycle in July’23). Looking ahead, the Fed may maintain its B/S size around $6.55T; which would be around 22% of the projected CY24 nominal US GDP of around $30.00T. Fed had also indicated previously (before COVID) that B/S size is around 20-22% of nominal GDP.

In Sep’2019, QT tapering (started in 2017) resulted in B/S size falling to around $3.77T from around $4.47T, which caused severe disruption in the US money/funding market, forcing the Fed to go for small QE even before COVID. In 2019, the U.S. nominal GDP was around $21.40T and the Fed’s B/S size fell to 17.6% of nominal GDP, below the 20% minimum/optimal levels required to keep sufficient liquidity for the US funding/money market.

Fed may be now targeting to keep ‘ample’ bank reserve around $3.00-2.50T (@10-8% of projected CY24 nominal GDP around $30T) in its B/S against 2019 QT target $1.50T to avoid any disruption in the funding market and to ensure financial stability. In Sep’19, bank reserve fell to around $1.4T, which was around 6.5% of nominal GDP, and triggered the REPO market crisis, forcing the Fed to launch ‘QE, not QE’.

Fed is now using ON RR/RRP (Overnight Reverse Repo Repurchase) for funding market stability, especially for smaller/regional US banks (around 10% of the US banking system), there is no visible effect of QT unlike during late 2019. Fed’s bank reserve now stands around $4.0T and ON/RRP around $0.70T. The Fed intends to taper/slow and then end QT when bank reserves are ‘somewhat’ above the level judged to be consistent with ‘ample’ reserve balances. Here, the challenge for the Fed is that this ‘ample’ minimum reserves floor is unknown. The money market stress in September 2019 revealed the threshold was much higher than $1.5T previously estimated. There are some concerns now bank reserves are close to the threshold, with overnight interest (interbank) rates trading in the lower half of the Fed’s target range.

The sharp fall in the RRP from $2.6T in May’23 to $0.980T in Jan’24 has boosted reserves. The RRP drains reserves as counterparties – typically money market funds and NBFCs – lend funds directly back to the Fed. In any way, recent Fed commentaries have indicated a reserves floor of 10%-12% of nominal GDP, or $3.00T-3.60T. This is higher than estimates from a year ago. Fed may like to keep $3.60T bank reserve, somewhat above ample levels of $3.0T bank reserve.

During QT times, the Fed is reducing its TSY +MBS holdings passively by not reinvesting original proceeds from maturing bonds, letting them mature and out of B/S. This is also causing corresponding bank reserves to decline. Now as the Fed is no longer buying US debts (TSYs + MBS) from the secondary market (unlike QE), US banks have to buy those US debts (mainly TSYs) but there is a risk of scarce liquidity as bank reserve also declined. In late 2019, QT failed as big banks led by JPM refused to lend to other banks, which created the panic and then the Fed had to step in as the ‘backstop’, which made money market participants confident enough to lend to each other as Fed will bail out any defaulted entity as the last resort. Although in reality, no bank comes to the Fed for the fund, the so-called Fed ‘put’ was able to pacify the US funding/money market, the biggest in the world.

Now Fed’s QT rate is $95B/M; i.e. $0.095T/M; if Fed intends to keep its B/S size around $6.55T (@22% on estimated CY24 nominal GDP $30T) from the existing $7.50T, it needs around 11-12 more months at the same rate of $0.095T/M; i.e. by Mar’25, Fed may be able to reduce its B/S size to around $6.55T and stop the QT (without going for any tapering ?).

But Fed’s Chair Powell is now indicating an imminent QT tapering, most probably from May’24. In that scenario, the Fed may taper the QT pace to around 0.048T~0.05T/M for 20 months till Dec’25, at almost 50% of the present pace of 0.095T/M to ensure smooth QT and the end of B/S shrinkage ensuring financial stability, especially for repo market. Alternately, the Fed may also run the QT tapering at around $75B/M ($0.075T/M) pace for 10-12 months from May’24 to close the QT by Jan-May’25 at B/S sizer around $6.55T and reserve balance around $3.60T (around 12% of US nominal GDP), ON/RRP around $0.40T, cash/currency notes around $1.00T and other securities.

After the 2019 money/funding market crisis/disruptions caused by QT, the Fed introduced the ON RP/RRP lending facility (Overnight Repo and Reverse Repo Repurchase Agreement) to ensure financial stability even during QT periods, which generally causes less intention among big banks/MMFs (money market funds) to lend each other. Thus, this time QT was not disruptive like we saw in late 2019, which made Trump furious against Fed/Powell as it caused higher bond yields and a Wall Street slide.

Overall, QT is a challenge for Fed as we have seen in late 2019. The U.S. has to issue never-ending debts (TSYs) to fund never-ending deficits and the Fed has to absorb from the secondary market through QE. Now during the QT phase, although the Fed is not actively selling TSYs, just passively letting them mature by not reinvesting original proceeds, this is sufficient for higher/elevated bond yields as bond prices fall due to lower/no demand from the Fed. Moreover, during QT, US Banks/NBFCs (DIIs) generally buy more TSYs and demand higher coupon rates (bond yield). This also causes lower bank reserve, creating REPO/funding market disruption a possible QT tantrum, and a new vicious cycle of QE (whatever may be the excuse), just after the QT.

Thus looking ahead, the Fed may keep B/S size around $6.55T, around pre-COVID levels to ensure financial/Wall Street stability along with Main Street stability (price stability and employment stability). Fed’s B/S size is presently around $7.50T (Mar’24 end). Depending upon the actual rate/reaction in the repo/funding market, the Fed may taper the QT from the present $0.095T/M to 0.050-0.075T/M for 20-12 months from May’24;i.e. Fed may end the QT by May’25-Dec’25 at B/S size around $6.55T. This B/S size is lower than the earlier market estimate of $6.95T and thus should be seen as more hawkish than earlier expected.

Also, rate cuts along with QT (even with a slower pace/tapering) should be less dovish because these are two contradictory steps/tools. As per the Fed’s estimates, a QT (B/S reduction) of around $2.5T over 2.5-3.5 years is equivalent to 50-75 bps rate hikes (higher bond yield). Here Fed is reducing its B/S from around $8.96T to almost $6.55-6.50T from June’22 to May/Dec’25; i.e. the reduction of around $2.5T B/S size over 3.5 years, which would be equivalent to almost 50-75 bps rate hikes, almost equivalent to projected 75 bps rate cuts by Fed in H2CY24.

Fed has to go for QT to prepare itself for the next cycle of QE (whatever may be the excuse/catalyst for the next wave of financial crisis—it may range from mini WW-III to even growing Chinese/US personal/commercial real estate crisis). But the Fed has to also lower bond yields by launching QQE (rate cuts +QE) to ensure lower borrowing costs for the government and also has to bail out itself and various big/small/regional banks from huge MTM loss for the HTM bond portfolio. Fed is now suffering around $160B unrealized loss (MTM) for its HTM bond portfolio.

On Tuesday, some of the focus of the market was also on JOLTS job openings data, which the Fed watches keenly for the underlying health of the labor market (as a leading indicator). The latest BLS/JOLTS (Job Openings and Labor Turnover Summary) flash data shows the number of job vacancies/openings in the U.S. (NFP-private + public) increased to 8756K in Feb’24 from 8748K sequentially, 9849K yearly, slightly above market expectations of 8750K, and near the lowest since Oct’23. In Feb’24, U.S. job openings decreased in decreased in information (-85K) and Federal Government (-21K).On the other hand, job openings increased in finance and insurance (+126K); state and local government, excluding education (+91K); and arts, entertainment, and recreation (+51K).

The 6M rolling average of JOLTS job openings to unemployed person ratio is now around 1.41 against the 2022 average of 1.87, the 2023 average of 1.43, and the pre-COVID level of 1.25. The U.S. economy is still suffering from a shortage of labor force due to various structural as well as cyclical issues including unfavorable demography, shrinkage of workforce after COVID, early retirements, legal immigration issues, lack of properly skilled workers, outsourcing, and an increasing number of multiple job holders/gig workers/freelancers. The U.S. labor market is still tight, although the headline unemployment rate was at 3.9% in Feb’24, just below the Fed’s red line of 4.0%, because of a surge in volatile youth and women unemployment.

Fed is now looking for at least a 1.25 ratio of job openings/unemployed persons consistently as a sign of the labor market cooling. The 6M rolling average data is not showing sufficient cooling in the labor market despite higher borrowing costs for businesses and also the resolution of immigrant workers' issues after COVID.

JOLTS job opening survey data is one of the preferred labor market indicators for the Fed to gauge the underlying strength of the labor market (as a leading indicator). U.S. labor force supply has now increased to 167426K from the Feb’20 (pre-COVID) level of 164458K as there are no COVID-related issues now; thus immigrant labor force increased. Also workers now no longer require being at home, taking care of parents and other members of the family as COVID is over.

In H2CY23, U.S. core inflation eased mainly due to a higher supply of labor force amid an easing of immigration (more supply of affordable/cheap migrant labor force from developing/poor countries),  some action by the fiscal authority (governments) to boost supply and relatively lower demand as a result of Fed tightening. Bur Fed is now not confident enough that this trend will continue at the same pace in H1CY24 and thus wants to see actual data (core inflation trajectory) for the next few months (H1CY24) for a definitive stance. Waller also clarified that some FOMC participants now projecting one/two less rate cuts in 2024 in its latest SEPs in Mar’24 than they saw in Dec’23.

On Tuesday, Cleveland Fed’s President Mester said:

·         I still expect the Fed can cut rates later this year

·         The Fed can cut rates gradually if the economy meets expectations

·         The Fed policy is in a good place to navigate risks to the economy

·         Doesn’t see case to cut rates at the next Fed meeting

·         Does not expect a smooth path back to 2%

·         Expect more inflation moderation at a slower pace

·         The bigger risk to policy is Fed cuts rates too soon

·         Risks to the economic outlook have become more balanced

·         A strong economy gives the Fed space to take stock before cutting rates

·         I see the labor market in better balance and expect a higher unemployment rate

·         I now see longer run funds rate at 3% versus the prior 2.5%

·         Revised up growth view, activity now seen just above 2% this year

·         Still expects the Fed can cut rates later this year but not at the next meeting

·         I am seeing some slowing in the economy but it's rebalancing

·         Disinflation can happen despite economic strength

·         Fewer job openings have been key to rebalancing the job market

·         Expects slower employment growth, 'slight uptick' in the unemployment rate

·         The policy is more effective when Fed and market views are aligned

·         The average family still struggling with inflation, explains a sour consumer mood

·         Election considerations won't impact Fed rate decisions

·         I won't pre-judge FOMC meeting but won't rule out a June rate cut

·         Three rate cuts for 2024 is still a reasonable forecast, but is a "close call"

·         We are watching oil prices, but the rise would need to be sustained to be an issue

On Tuesday, SF Fed’s President Daly said:

·         We need to see how long to leave rates where they are; Inflation is coming down; It's bumpy and slow--

·         There is no urgency to adjust the rate

·         There's a supply and demand imbalance in the housing market

·         The economy is improving, there is a path where interest rates start to adjust this year, just not there yet

·         Standing pat is the right policy for the moment

·         If the labor market starts to falter, or inflation comes down faster, we are in a position to cut rates more

·         The probability of recession is not very high right now

·         We don't see weaknesses emerging

·         When we say 2% is the inflation goal, we mean it-- We're resolutely committed to restoring inflation to the target

On Tuesday, China's President Xi said after a telephone conversation with U.S. President Biden:

·         We hope that the US side will translate into action the positive statement made by President Biden of not supporting Taiwan independence

·         China will not sit idly by if the US insists on suppressing China's high-tech development and depriving China of its legitimate development rights

·         Taiwan is the first red line that cannot be crossed in China-US relations

On Tuesday, the White House also released the US version (readout) of the telephonic conversation between President Biden and Xi:

“President Joseph R. Biden, Jr. spoke today with President Xi Jinping of the People’s Republic of China (PRC).  The call follows the two leaders’ meeting in Woodside, California in November 2023.  The two leaders held a candid and constructive discussion on a range of bilateral, regional, and global issues, including areas of cooperation and areas of difference.  They reviewed and encouraged progress on key issues discussed at the Woodside Summit, including counter-narcotics cooperation, ongoing military-to-military communication, talks to address AI-related risks, and continuing efforts on climate change and people-to-people exchanges.

President Biden emphasized the importance of maintaining peace and stability across the Taiwan Strait and the rule of law and freedom of navigation in the South China Sea.  He raised concerns over the PRC’s support for Russia’s defense industrial base and its impact on European and transatlantic security, and he emphasized the United States’ enduring commitment to the complete denuclearization of the Korean Peninsula.  President Biden also raised continued concerns about the PRC’s unfair trade policies and non-market economic practices, which harm American workers and families. 

The President emphasized that the United States will continue to take necessary actions to prevent advanced U.S. technologies from being used to undermine our national security, without unduly limiting trade and investment. The two leaders welcomed ongoing efforts to maintain open channels of communication and responsibly manage the relationship through high-level diplomacy and working-level consultations in the weeks and months ahead, including during upcoming visits by Secretary Yellen and Secretary Blinken.”

Moreover, on late Tuesday, the U.S. Treasury spokesperson said:

·         Secretary Yellen to meet with People's Bank of China Governor Pan Gongsheng and former Vice Premier Liu He in April

·         Yellen to Learn More About China's Property Market and Growth Targets

·         Yellen aims for strong economic ties with China, to prioritize safeguarding US national security and human rights with targeted actions

Market impact:

On Tuesday, Wall Street Futures, Gold slumped on hotter than expected JOLTS job openings and factory order data coupled with the Fed’s indication of rate cuts in H2CY24, most probably from Sep’24 and lower than expected B/S size ($6.55-6.50T vs earlier estimate $7.00-6.95T). Fed may go for rate cuts along with ongoing QT (even at a slower pace-tapering)-this is less dovish than simple rate cuts. The cumulative effect of B/S reduction through QT by around $2.5T over 2.5-3.5 years is equivalent to 50-75 bps rate hikes (higher bond yields), which is almost equivalent to estimated 75 bps rate cuts in H2CY24.

Thus Fed’s overall plan of rate cuts + QT may be less dovish than earlier expected despite Fed attempts to downplay the effect of QT; US bond yields also surged to multi-week highs. The Fed’s B/S size is now falling below $7.50T; i.e. below 25% of the estimated CY24 US nominal GDP of $30.00T, which is a red zone (20-25%) for US funding/money market liquidity as we have seen during late 2019 QT tantrum.

In any way, on late Tuesday Wall Street Futures, Gold also recovered from Fed’s QT tantrum panic low after Fed’s Mester said she is not completely ruling out the possibility of a June rate cut. Subsequently, the FFR swap implied probability indicated around 60% chance of a rate cut in June against 50% earlier in the session and almost 90% a few months ago. But if we minutely read comments by both Fed speakers Mester and Daly at the SF Fed conclave, both stressed no rush to cut rates and continue to advocate higher for longer policy for the time being. Fed may not go for any rate cuts in H1CY24 and may go for the same only from Sep’24 after observing actual H1CY24 data (core inflation, employment and GDP), which will be published in mid/end July (core CPI + core PCE inflation).

On Tuesday, Gold, oil was also boosted by escalating Gaza war/Middle eat geopolitical tensions after Israel destroyed the Iranian consulate in Syria’s Damascus. Although, Iran is publicly vowing for ‘revenge’, the U.S. is ensuring no escalation through back channel diplomatic talks with Iran. Additionally, Oil is also getting a boost from OPEC+ production cut result and the conspiracy theory that Putin & Co may ensure oil above $100 by Sep’24 to keep US incumbent President Biden under public pressure ahead of the Nov’24 election. Fed may also face some issues for planned rate cuts if oil indeed jumps and stays around the $100 mark for long.

On Tuesday, Wall Street was also buoyed by hopes of good relations between the US and China, the world’s two largest economies. Despite respective domestic political compulsions, both the US and China need each other for economic development, economic prosperity, and growth. The US is China’s biggest foreign customer for goods/merchandise export and vice-versa; various US MNCs are also heavily dependent on Chinese demand/consumption. Thus US is now eager for a growing China, not under any slowdown.

On Tuesday, blue chip DJ-30 slumped almost -400 points, while tech-savvy NQ-100 lost -0.90% and broader SPX-500 plunged -0.70%. Wall Street was dragged by healthcare (political populism/price cuts ahead of the election), consumer discretionary, real estate, techs, consumer staples, industrials, banks & financials and materials, while boosted by energy (higher oil), utilities and communication services to some extent. Scrip-wise, Wall Street was dragged by United Health, Amgen, Nike, Walmart, Intel, Boeing, Microsoft and Apple, while boosted by Walt Disney, Verizon, Salesforce, Chevron and Caterpillar.

The US The healthcare sector tumbled after a 3.7% yearly increase in government payments for Medicare Advantage, matching previous proposals. Tesla slumped after than expected delivery number in Q1CY24, which is the 1st estimated decline since COVID times in 2020. China's slowdown is affecting Tesla. The market is now also expecting Trump tariffs on Chinese goods to continue even under Biden for domestic political populism (despite Xi-Biden talks). This may result in retaliatory tariffs by China on US goods & services. Intel slumped after reporting around $7B accumulated operating loss for its chip-making division; AMD and NVIDIA also tumbled.

Conclusions:

The Fed may go for -75 bps rate cuts in September, November, and December’24. By 18th September (Fed MPC date), the Fed will have complete data for core inflation and also unemployment/real GDP data for H1CY24 and also Aug/July’24 to have the required ‘higher confidence’ to go for rate cuts. Fed may bring down the repo rate to +4.75% by Dec’24 from present +5.50%.

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.6%. Fed may cut 75 bps in H2CY24 if the 6M rolling average of core inflation (PCE+CPI) indeed eased further to +3.0% by H1CY24.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C-D)*(E-B)

=1.50+2.00+ (2.60-2.00)*(4.50.00-2.00) =1.00+2+ (0.60*2.50) = 3.00+1.50=4.50% (By Dec’24)

Here:

A=desired real interest rate=1.50; B= inflation target =2.00; C= Actual real GDP growth rate for CY23=2.6; D= Real GDP growth rate target/potential=2.00; E= average core CPI+PCE inflation for CY23=4.50

Fed may announce a plan for QT tapering/closing in the May meeting and should have closed the same before going for rate cuts in H2CY24. Fed, the world’s most important central bank may not continue QT (even at a reduced pace) and go for rate cuts at the same time as QT, and rate cuts are contradictory, although Fed/Powell kept the option open, at least theoretically. Thus assuming an absurd/bizarre phenomenon, the Fed may go for -75 bps rate cuts in H2CY24, most probably from Sep’24 after deciding about the possible B/S size to ensure money market stability

Looking ahead, the Fed may keep B/S size around $6.55T, around pre-COVID levels to ensure financial/Wall Street stability along with Main Street stability (price stability and employment stability). Fed’s B/S size is presently around $7.50T (Mar’24 end). Depending upon the actual rate/reaction in the repo/funding market, the Fed may taper the QT from the present $0.095T/M to 0.050-0.075T/M for 20-12 months from May’24;i.e. Fed may end the QT by May’25-Dec’25 at B/S size around $6.55T. This is lower than the earlier market estimate of $7.00T and thus should be seen as more hawkish. Also, rate cuts along with QT (even with slower pace/tapering) should be less hawkish.

Ahead of the Nov’23 U.S. Presidential election, White House/Biden/Fed/Powell is more concerned about elevated inflation rather than the labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some incumbency wave (dissatisfaction) among general voters against Biden admin (Democrats).

Thus Fed is now giving more priority to price stability than employment (which is still hovering below the 4% red line) and is not ready to cut rates early as it may again cause higher inflation just ahead of the November election. Fed may hike only from Septenber’24, which will ensure no inflation spike just ahead of the Nov’24 election (as any rate action usually takes 6-12 months to transmit in the real economy), while boosting up both Wall Street and also Main Street (investors/traders/voters). Fed hiked rate last on 26th July’23 and may continue to be on hold till at least July’24; i.e. around 12 months for full transmission of its +5.25% cumulative rate hikes effect into the real economy.

Overall, the Fed’s mandate is to ensure price stability (2% core inflation), and maximum employment (below 4% unemployment rate) along with financial/Wall Street stability as well as lower borrowing costs for the government. As the US is now paying almost 15% of its tax revenue as interest on debt, the Fed will now not allow the 10Y US bond yield above 4.50-5.00% at any cost.

Bottom line:

Fed may continue QT (even at a slower pace) and go for a rate cut cycle at the same time despite these two policy actions being contradictory. Thus the Fed may go for rate cuts of -75 bps cumulatively in September, November, and December’24 for +4.75% repo rates from the present +5.50%.

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

Whatever may be the narrative, technically Dow Future (39475), now has to sustain over 39600/39800 and may again scale 40000/40200-40600/40700 levels for any further rally to 42600  levels in the coming days; otherwise, sustaining below 39550 may again fall to 39250/38700-38200/37950 levels in the coming days.

Similarly, NQ-100 Future (18270) now has to sustain over 18350/18500-18600/18700 levels for any rebound towards 19000/19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18800-18700, NQ-100 may gain or fall to around 18000/17500-17200/16875 in the coming days.

Also, technically Gold (XAU/USD: 2271 now has to sustain over 2300 for any further rally to 2315/2330-2350/2375; otherwise sustaining below 2290/2270-22245/2240, may again fall to 2220/2210 and 2200/2195-2190/2180 and 2175/2145*, and further to 2120/2110-2100/2080-2060/2039 and 2020/2010-2000-1995/1985-1975 and even 1940 may be on the card.