Wall Street, Gold, bonds almost flat on soft CPI and hot PPI

·         Although the market is now expecting Fed rate cuts from Sep’24, the Fed may not oblige before Dec’24; Trump is set to win big against Biden; Cryptos surged briefly

On Thursday, Wall Street Futures and Gold surged on hopes of an early Fed rate cut from Sep’24 rather than Dec’24 after than expected inflation report. But SPX-500 and NQ-100 soon stumbled from record highs after less dovish Fed talks, indicating the much-awaited start of rate cuts from Dec’24 rather than Sep’24. Additionally, Gold was undercut by hopes & hopes of an imminent Gaza war ceasefire. Techs dragged NQ-100 on sky-high valuation concerns, while banks & financials helped DJ-30 amid delay-dallying tactics by the Fed to implement Dodd-Frank and BASEL-III regulatory norms despite increasing pressure from US Congress. On early Friday, Wall Street Futures and also Gold were under stress on hotter than expected US PPI report.

On Friday, the focus of the market was on US PPI data after soft inflation (CPI) data a day before as the Fed will eventually start cutting rates only when it feels enough confidence that core inflation is sustainably easing towards +2.0%. Fed primarily follows core PCE inflation, data of which is published generally around the last week after core CPI and PPI data around mid-month of every month. The market usually has an idea about the possible rate of core PCE inflation at month's end after getting core CPI and core PPI data mid-month.

On Friday, the BLS flash data (NSA) showed annual (y/y) U.S. core PPI (w/o food & energy) increased +3.0% in June’24, from +2.6% sequentially, lower than the market consensus of +2.5% and the highest since Apr’23.

On a sequential (m/m) basis (SA), the U.S. core PPI increased +0.4% in June’24 from +0.3% in the previous month and below the market expectations of +0.2% increase. As per NSA data, the US core PPI increased by +0.5% in June against +0.1% the previous month.

Overall, after the latest 4M revision, the 2024 (YTD) average of core PPI is now around +2.4% in June’24 (vs prior +2.2%) against +2.9% in 2023, +7.8% in 2022, and pre-COVID levels around +1.5%; the 6M rolling average of US core PPI is now around +2.4% (vs earlier +2.2%). The 6M rolling average of sequential (M/M) core PPI is now around +0.3% in June’24 against +0.2% prior, while the 2024 (YTM) sequential core PPI rate is now around +0.3%; the Fed needs +0.1% core sequential core PPI rate on a sustainable basis for its target/pre-COVID levels of +1.50%, so that core CPI would come around +2.0% targets.

On Tuesday, the BLS data (NSA) also shows U.S. annual (y/y) total PPI increased by +2.6% in June’24 from +2.4% reading sequentially, above market expectations of +2.3% and the highest since Mar’23.

On a sequential (m/m) basis, the U.S. PPI increased +0.2% in June’24, from a +0.0% increase (unchanged) in the previous month, and above market forecasts of a 0.1% increase.

Overall, after the latest 4M revision, the 6M and YTM rolling average of US PPI is now around +2.0%  (prior +1.7% and +1.8%) against the 2023 average of +2.0%.

In June’24, producer prices (PPI) for services increased +3.5% (vs +2.6% sequentially), while that of goods increased +1.0% (vs +1.6% sequentially).

In June’24, the annual US service PPI was boosted by trade, transportation & warehousing, portfolio management, securities brokerage, and inpatient care, while goods PPI was dragged by energy, and industrial chemicals while boosted by foods, industrial items, and cigarettes. Sequentially, the US PPI (Producer Price Index) was boosted by services (+0.6%), while dragged by goods (-0.5%), mostly due to a decline in energy/fuel, processed poultry, and fresh & dry vegetables.

Also, fine prints of BLS flash data show US core personal consumption for the PPI index, equivalent to core PCE increased around +0.4% in June’24 after a +0.6% advance in the previous month, while increasing +3.3% annually (y/y).

From the above sequential data and also that of core CPI sequential rate, overall, the average sequential rate of core PCE inflation may be around 0.3-0.5% (~+0.4%) in June’24. Even if we assume a lower end +0.3% sequential rate of core PCE inflation in Jun’24, the annual (y/y) rate should come to around +2.7% against +2.6% in May’24. In that scenario, the 6M rolling average of core PCE inflation should be around +2.8% against the 6M rolling average of core CPI around +3.6%, and the 6M rolling average of US core inflation (PCE+CPI) would be around +3.2%; the Fed may not start the rate cut cycle until this average core inflation (PCE+CPI) goes at least to +2.6% on a sustainable basis. This may not be possible before Dec’24. By Sep-Oct’24, this average core inflation should be around 2.9-2.8%, just below +3.0% on a consecutive basis, which should provide the Fed the much-awaited confidence to indicate the start of eleven rate cuts cycle (every QTR) from Dec’24.

In that scenario, the Fed may give a definitive signal for eleven rate cuts from Dec’24 QTR onwards in its Sep’24 dot-plots, just before the Nov’24 election to keep both Wall Street, Main Street as well as Capitol Hill Street happy; both Democrats and Republicans may not object Fed in that case; Powell will keep both sides of the political Street happy.

On Friday, the UM (University of Michigan) flash data showed US consumer sentiment for July eased to 66.0 from 68.2 sequentially, below the market consensus of 68.5 and lowest since Nov’23 amid still elevated inflation/higher cost of living and election/political & policy uncertainty, although they are also expecting incrementally lower inflation in the coming months.

On Friday, the UM flash data showed US 1Y inflation expectations eased to +2.9% in July from +3.0% sequentially, in line with market expectations of +2.9% and the lowest since Mar’24. Also, the 5Y inflation expectations eased to a four-month low of 2.9% in July, compared to 3% in each of the previous three months.

The Fed usually goes by a 6M rolling average of core PCE + core CPI inflation for any important policy move. As per core CPI and core PPI data, the June core PCE inflation may be around 2.7-2.8% vs 2.6% sequentially. In that scenario, the 6M rolling average core PCE inflation would be around 2.8-2.9% in June, while the 6M rolling average of U.S. core CPI inflation is now around +3.6% in June; i.e. 6M rolling average of US core inflation (CPI+PCE) would be around 3.2-3.3%, still far above Fed’s +2.0% targets, but not very much above +3.0% ‘confidence building’ levels for Fed.

We may see +2.9% average (6MRA) US core inflation by Sep’24 (just before the Nov’24 US election), so that the Fed may get the much awaited required ‘confidence’ to indicate a definitive start of multiple (eleven) rate cut cycles from Dec’24, just after the Nov’24 US Presidential Election to keep both Democrats and Republicans happy.

Overall, after the latest revisions, the average core PCE inflation for 2023 was now around +4.1%, while the same for core CPI inflation was +4.8%, and an average of core inflation (PCE+ CPI) was around +4.5% (for 2023), which is now around +3.3% in 2024 (YTM-May). We may see a slower pace of disinflation in H2CY24 due to lower base effects and higher spending for the US election coupled with elevated crude oil prices amid lingering uncertainty about the Gaza and Russia-Ukraine war trajectory.

Fed needs an average sequential core PCE inflation rate of around +0.2% on a sustainable basis for its +2.0% core PCE inflation targets. But it’s still hovering around +0.3% for the last 6 months, while jumping +0.5% even in Jan’24. That’s why Powell/Fed is repeatedly pointing out Fed is not confident enough still now for the disinflation process. Although there was a rapid disinflation rate in H2CY23, the same was stalled in Q1CY24 but again gets some pace in Q2CY24; thus Powell has said in the Congressional Testimony that Fed is now getting some confidence about the disinflation process and subsequent rate cuts, but the confidence is still not enough to go for rate cuts in the immediate QTR (Q3CY24) and Fed may continue to be ‘wait & watch” stance to monitor/assess actual data for Q3CY24 and outlook thereof for any cut in Q4CY24 (Dec’24).

Ahead of Nov’24 US Presidential Election, in his semi-annual Congressional Testimony last week, Fed Chair Powell was heavily grilled by both Democrats and Republicans for still elevated inflation and increasing unemployment rates affecting ordinary Americans (general public), who is the largest vote bank for any political part. Although  Powell acknowledged elevated inflation (still almost +20% up from pre-COVID levels against normal +10% in 4-5 years @2% on an average), Powell also pointed out that even at the 4.1% headline unemployment rate (3.9% 6M rolling average), because of the Fed, it’s still well below the historically higher unemployment rate of 4.5% (Fed red line).

Thus Fed has still space to keep a higher restrictive rate to produce more slack in the economy to bring inflation down. Although Powell was under pressure from some Democrats for the start of rate cuts by July/Sep’24, just before the Nov’24 US election, Powell was adamant about sounding politically neutral and made it clear that as an independent central bank, the Fed will only go by economic data and outlook rather than any political/election calendar.

Ahead of the US Nov’24 election, both Democrats and Republicans are trying to score on politically sensitive issues like the recent surge in immigration, unaffordable housing, and its effect on inflation and employment. Although higher immigration has helped to cool the US labor market in the last two years by adding more supply of workers (skilled/unskilled) in lower category of jobs,  it’s also creating fresh/higher demands for goods & services including housing/renting and causing more inflation (increasing demand vs constrained supply).

Thus to serve an increasingly bigger/more populous economy, the US has to increase the supply capacity of the economy, especially both social (education, healthcare, housing) & traditional/transport infra including a wide network of high-speed railways and smart cities (like in China) to meet growing demand of the increasing population and balance/reduce inflation.

But most of the time, the Ruling Party in the White House is a minority government and there are various issues for a common bipartisan agreement for such infra spending; Democrats (Biden admin) are usually more infra savvy, while Republicans (Trump admin) are almost the opposite, relying on more tax cuts. As per some reports, Trump may even end the income tax and instead go for higher VAT/sales tax rates of 35% (?) in the US! As usual, Powell was heavily grilled by both sides of the aisle (Democrats and Republicans)  for his comments on infra stimulus, higher debts, and the housing problem of the US economy, Powell chose most of the time to not comment on such politically sensitive issues to sound/look politically neutral.

As the flood of immigrants is now a political/election issue, many US Lawmakers also pointed out Fed should allow higher wage growths to bring back around 7M of US native workers from the sideline to encourage them to join the active labor force rather than receiving dole money (unemployment benefits) lifelong. But Powell clearly said immigration, and fiscal/infra stimulus issues are with the government, not the Fed’s.

Conclusions:

The Fed may start the long-awaited eleven rate cut cycle from Dec’24 and may also indicate the same by Sep-Oct’24; the Fed will be in ‘wait & watch’ mode till at least Dec’24. But at the same time Fed will continue its jawboning (forward guidance) to prepare the market to ensure the official dual mandate (maximum employment, price stability) along with an unofficial mandate to ensure financial stability (Wall Street and bond market); Fed may not allow core real bond yield (10Y) above +1.0% under any circumstances to manage government borrowing costs, which is now hovering around 15% of US core tax revenue, quite elevated against EU and China’s 6% levels.

At present real repo rate (adjusted 6MRA core CPI) is around +1.90% in 2024 (till June), almost at around +2.0% upper range against +0.23% in 2023 (almost at zero levels). These restrictive levels (real positive) of borrowing costs are creating some additional slack in the economy to compress elevated demand so that it can match with the presently constrained supply capacity of the economy and eventually inflation goes down to around +2.0% target on a sustainable basis. Fed needs at least 12 months on average to continue real positive borrowing costs around 1.50-1.00% to affect demand and bring inflation down.

Looking ahead, core CPI may fall around +3.0% levels by Sep’24 from +3.3% in June’24, which may prompt the Fed to have the required ‘confidence’ that core CPI is falling towards +2.0% targets on a sustainable basis in the coming months and thus Fed may start cutting rates from Dec’24. Fed has projected in the June’24 dot-plots -25 bps rate cut in 2024, -100 bps rate cuts each in 2025 & 2026, and -50 bps in 2027 for a terminal neutral repo rate +2.75%.

Fed may not cut rates in Sep’24, just before the Nov’24 US election to avoid any political controversy. But the Fed may start the rate cut cycle from Dec’24 QTR (Q4CY24) and may cut cumulatively eight times in 2025-26 at each QTR end by -25 bps each; then Fed may cut twice in 2027 at June’27 (H1CY27) and Dec’27 (H2CY27) @-25 bps each. One month of data may not change the Fed’s narrative about higher for longer stance as the headline unemployment 6M rolling average is still below 4.5%, while the same for core CPI inflation is still above 3.0% (the Fed generally considers at least 6M rolling average of economic data to suit its narrative).

The 6M rolling average of US core inflation in the eyes of the Fed (PCE+CPI) would be around +3.3% in June; the Fed may not start the rate cut cycle until this average of core inflation (PCE+CPI) goes at least below 3.0% on a sustainable basis. This may not be possible before Sep’24; i.e. Fed may not get the required levels of confidence for indicating a definitive rate cut before Sep’24. In that scenario, the Fed may give a definitive signal for eleven rate cuts from Dec’24 QTR onwards in its Sep-Dec’24 dot-plots, just before/after the Nov’24 election to keep both Wall Street, Main Street as well as Capitol Hill Street happy; both Democrats and Republicans may not object Fed in that case; Powell will keep both sides of the political Street happy.

Ahead of the Nov’24 U.S. Presidential election, White House/Biden and also Fed/Powell are more concerned about elevated inflation rather than the ‘healthy’ labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some anti-incumbency wave among the general public (voters) against Biden admin (Democrats) due to relatively higher cost of living. Thus Fed is now giving more priority to price stability than employment (which is still healthy- 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 and Republicans (Trump & Co) may also accuse Powell of favoring Democrats (Biden admin) to win the election.

Overall, the Fed’s mandate is to ensure price stability (2% core inflation), and maximum employment (below 4.5% 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 4.50-4.75% at any cost (against present levels of average core CPI around +3.60%); i.e. Fed will not allow core real bond yield above +1.00%. Fed has to also ensure Wall Street stability by keeping SPX-500 TTM PE around 25 rather than lower/mean levels around 20.

Also, the reduction of Fed B/S from around $8.97T to around $6.60T by Dec’25 (projected); i.e. around $2.50T (~$2.37T) reduction over 2.5-3.00 years is equivalent to a rate hike of around +50 bps (higher 2Y bond yield). Fed had boosted its B/S from around $3.86T in late September’2019 (after the QT tantrum) to around $8.97T in Apr’22; i.e. over $5T in a matter of 32 months (@0.16T/M) to fight previous QT and COVID induced financial crisis.; but in the process may have also caused huge inflationary pressure along with the deluge of COVID fiscal stimulus and direct fund transfer; all these may have caused the vicious cycle of higher deficits, higher debts, higher devaluation, higher borrowing costs, and still elevated inflation.

Fed will continue the QT at a reduced rate of around 40B/M till Dec’25 for a B/S size of around $6.60-6.50T (around 22% of estimated US nominal GDP of around $30T by CY26). Fed may continue the QT (even at an officially slower pace) and rate cuts at the same time despite simultaneous rate cuts and QT being contradictory. Fed may say (like BOC) that as long as core inflation is above certain levels (say +3.00%), then the Fed may continue to maintain real policy rate in the restrictive zone (say 1.50-2.00% above average core inflation), even after the Fed may continue both rate cuts and QT to reduce overall restrictiveness in a limited way.

When core inflation moves closer towards +2.0% targets by Dec’25, then the Fed may close the QT, continuing for only rate cuts, which should ease financial conditions more, at least theoretically than the contra combination of rate cuts and QT at the same time. Overall, Fed rate cuts along with QT (even at a slow pace) in 2025 may be less dovish than pure/only rate cuts (without QT) as QT is also equivalent to rate hikes to some extent.

All other major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may be compelled to follow the Fed’s real rate action to keep present policy differential with the Fed despite the symbolic 25 bps rate cuts by ECB, BOC in June for domestic political/election compulsion. As USD, is the primary global reserve/trade currency, any meaningful negative divergence with the Fed will result in higher imported inflation, everything being equal; for example, if the ECB indeed goes for 50-75 bps rate cuts in H2CY24, while the Fed is still on hold, then EURUSD may slip further towards parity (1.0000), which will result in higher imported inflation as the EU is dependent quite heavily on imported goods, foods, and fuel/commodities.

In this way, no major G20 Central Bank will take such rate action/cuts alone as there is a routine/regular coordination/consultation between all major central banks for a coordinated/synchronized policy action to avoid disorderly FX movement. The Fed also not seeking a very strong USD as it would eventually affect US export competitiveness. Thus all major central banks are now focusing on maintaining proper balance and coordination with the Fed, whatever may be the domestic political/election, inflation/economic narrative, and jawboning; they can’t afford to diverge too much against the Fed, all being equal.

Like in India, the US Presidential election in Nov’24 may be also acting as a big/moderate fiscal stimulus amid huge election spending, which may likely boost inflation again or prevent the disinflation process, making the Fed’s job harder to cut rates before Nov’24 election. Moreover, the Biden admin is spending huge for the US private defense industry in the name of aid to Ukraine and even Israel and will also actively participate in the reconstruction process of both Gaza and Ukraine when the war finally stops; the deluge of deficit/fiscal spending, debt, and money/currency (USD) printing is also boosting overall inflation (3D-deficit, debt and devaluation).

Thus almost all major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may not cut rates before Dec’24 to see the actual Fed action; if the Fed remains on hold till Dec’24; no central bank will go against the Fed irrespective of any narrative/rhetorics and make LCU weaker against USD, causing higher imported/total/core inflation in the process; all central banks led by Fed will continue the 24/7 jawboning to keep bond yields under control (indirect YCC like BOJ) and a vibrant financial/money/FX market; There may be a synchronized rate cut among leading G20 Central Banks led by Fed from 2025.

Trump is set to win big after the bizarre ‘assassination’ attempt on his Saturday election campaign. There are serious security lapses in such election campaign speech in the US, where guns are freely available. The bullet barely missed Trump’s skull/head on Saturday as he momentarily ducked to read a chart/notes regarding immigration during his election speech. Although it may be an act of domestic terrorism/political acrimony by an unprofessional ‘domestic terrorist’, if it was an act of a professional international terrorist, the consequence may be serious/ severe.

This follows after the terrible election debate performance of Biden with Trump. Although Trump prefers for continuation of the 2017 tax cut policies beyond 2025, he may again adopt a nationalist trade war stance. Trump may again play the China tariffs card and thus China-savvy stocks such as Nike, Starbucks, Amazon, Apple, and Boeing were under stress. But after the terrible debate performance of ‘aging/sleeping Joe’ (Biden), Democrats may replace Biden with some other ‘young & dynamic’ person. But both Biden and Trump are in their 80s now; while Biden’s image is relatively clean (despite his son Hunter’s ‘laptop’ and alleged crony connection with China), Trump’s image is messed up after Jan’20 ‘Congressional coup’ (after election defeat to Biden). Trump is still alleging election manipulation by Biden.

Overall, Trump’s win, or even trifecta may be negative for Wall Street to some extent (especially from life time high zones) as there is no scope for fresh tax cuts for corporations, although he may try to extend the 2017 tax cuts beyond 2025, there will be immense opposition in the US Congress/Senate. Moreover, Trump may again play China and even the EU/German trade war card for domestic political compulsion along with immigration (legal/illegal), which may be positive for inflation. Under Trump, there may be also less emphasis on infra spending, especially in high-speed railways. And Trump admin may be also positive for health insurance, oil, and banks & financials, while negative for RE. But at the same time, an emphasis on lower immigration may also cause lower demand and lower inflation to some extent.

As per reports, Trump has emerged as the pro-crypto candidate leading up to this year’s US presidential election and is set to attend the Bitcoin Conference in Nashville, Tennessee on July 27. Meanwhile, crypto executives recently met with US officials over regulatory crackdown concerns as the Biden admin’s anti-crypto stance kept the industry on edge. Bitcoin came under pressure in recent weeks as investors pulled capital out of Bitcoin ETFs, spurring massive liquidations in leveraged traders. Bankrupt Japanese exchange firm Mt. Gox’s repayments and heavy Bitcoin selling from Germany’s Bundeskriminalant also exacerbated the selloff.

In Brief, Trump may be positive for USD/US bond yields and negative for Equities (higher borrowing costs, China/EU trade tantrum, and nationalistic policies), but positive for Cryptos to some extent to limited ability for a monumental change in policies due to various checks & balances in the US political & policy system.

Market impact:

On Friday, Wall Street Futures and Gold stumbled from a softer CPI high to some extent after a hotter-than-expected US PPI report and lower consumer confidence. But still, the market-implied probability of a Sep’24 rate cut odds is hovering around 88%; very high. Looking ahead, if the Fed doesn’t want to start the rate cut cycle from Sep’24, just ahead of the Nov’24 election, then the Fed has to jawbone hard (mawkishly) to talk down the rate cut probability. Overall, Wall Street and Gold surged for the week on hopes & hypes of an early Fed rate cut from Sep’24 rather than Dec’24. The market is now expecting -50 bps rate cuts in H2CY24 against the Fed’s June dot plots of -25 bps.

But Wall Street and Gold also stumbled from weekly highs after less dovish Fed talks, indicating the much-awaited start of rate cuts from Dec’24 rather than Sep’24. Additionally, Gold was undercut by hopes & hopes of an imminent Gaza war ceasefire, while Wall Street was also boosted to some extent. Also, Techs dragged NQ-100 on sky-high valuation concerns, while banks & financials helped DJ-30 amid delay-dallying tactics by the Fed to implement Dodd-Frank and BASEL-III regulatory norms despite increasing pressure from US Congress.

On Friday, Wall Street was boosted by consumer discretionary, materials, techs, utilities, real estate, healthcare, industrials, consumer staples, banks & financials (subdued report card/guidance from JPM), and energy, while dragged by communication services. Script-wise, Wall Street was boosted by Intel, IBM, Amgen, Home Depot, United Health, Caterpillar, and Apple, while dragged by JPM, Merck, Boeing, Walmart, and McDonald’s.

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

Whatever the narrative, technically Dow Future (40500) has to sustain over 40700 for any further rally to 41000/41300-41500/41800 and 42000-42700 in the coming days; otherwise sustaining below 40650, DJ-30 may again fall to 40400/40200-40000/39900 and further 39800/39600-39400/39200 and 39000/38800-38600/38300 in the coming days.

Similarly, NQ-100 Future (20600) has to sustain over 21050 for a further rally to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 21000/20900-20700/20300 may again fall to 20000/19850-19750/19650* and 19450/19100-18800/18500 and 18400/18100-18000/17700 and 17600/17500-17300/17150 in the coming days.

Technically, SPX-500 (5680), now has to sustain over 5750 for any further rally to 5850/5800-6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5700/5600-5575/5550 may again fall to 5500/5450-6375/5350 and 5250/5200-5175/5100 and further 5000/4900*-4850/4825 and 4745/4670-4595/4400* in the coming days.

Also, technically Gold (XAU/USD: 2410) has to sustain over 2435 for a further rally to 2455*/2475-2500/2525 and 2550/2575-2600/2650 in the coming days; otherwise sustaining below 2425/2390-2375/2355, may further fall to 2320/2300-2290/2275* in the coming days.