Wall Street, Gold recovered on dovish Fed talks; techs helped

Wall Street Futures were already under stress on fading hopes of early and deeper Fed rate cuts amid hotter-than-expected economic data (core inflation and retail sales). Also overall, Fed talks are more hawkish than expected as the Fed is now trying to convince the market that a rate cut may not come in H1CY24. But the Fed may go for QT tapering and close the QT by H1CY24.

On Wednesday, European/US stock Futures recovered from early Fed panic low as Lagarde sounded less hawkish than earlier; but stocks were also undercut on hotter-than-expected core inflation in the U.K. But eventually, Wall Street Futures stumbled on hotter than expected US retail sales, which may keep the Fed on hold till at least H1CY24 rather than any rate cuts from March’24. The market-implied probability of a -25 bps Fed rate cut in March is now around 50% against 80% a few weeks ago.

On Thursday, some focus was also on U.S. jobless claims (seasonally adjusted), which serves as a proxy for the unemployment trend/overall labor market conditions. The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI-under insurance) decreased to 187K in the week ending 18th January from 203K in the previous week, below market expectations of 207K and lowest in the last 16-months (since Sep’22).

The 4-week moving average of initial jobless claims, a better indicator to measure underlying data, as it removes week-to-week volatility, also decreased to 203.25K on the week ended 13th January from 208.00K in the previous week.

The continuing jobless claims in the U.S., which measure unemployed people who have been receiving unemployment benefits for a while/ more than a week or filed for unemployment benefits at least two weeks ago (under UI), decreased to 1806K in the week ending 4th January, from 1832K in the previous week, lower than the market expectations 1845K and lowest since mid-Oct’23.

The 4-week moving average was 1848.00K, from the previous week's average of 1861.750K. The advance seasonally adjusted insured unemployment rate was 1.2% for the week ending 6th January from 1.2% the previous week (unchanged). The advance numbers of seasonally adjusted insured unemployed persons were around 1806K for the week against 1832K for the previous week.

The continuing jobless claims of all types are also a proxy for the total number of people receiving payments from state unemployment programs, i.e., the overall trend of unemployed persons (insured).

Overall, as per seasonally unadjusted continuing jobless claims under all categories (UI) of around 2029K (2-week rolling average) and assuming average uninsured employees/self-employed (not getting any UI benefit) of around 4200K (?), estimated unemployed persons would be around 6229K in Jan’24 against 6268K sequentially. Further, if we assume the labor force is around 168200K, the unemployment rate would be around 3.7% in Jan’24 from 3.7% sequentially. The estimated number of employed persons would be around 161971K in Jan’24, an addition of around +788K sequentially against a contraction of -683K in Dec’23 (as per Household survey).

Overall, the latest unemployment claims trend indicates a still robust U.S. Labor market, supporting the Fed’s plan to hold rates at least H1CY24. Subsequently, Wall Street Futures and Gold slipped to some extent briefly.

On Thursday, Fed’s Bostic said:

·         Open to cutting rates before July if convincing evidence of slower inflation

·         Given the uncertainty, it's unwise for the Fed to lock in any approach at this point

·         I am open to starting rate cuts before July if there is convincing evidence that inflation is slowing faster than I anticipate

·         Repeats baseline is for rate reductions starting in Q3, with the care needed not to cut too soon and risk renewed demand and price pressures

·         Cites possibility conflicts around the world could again complicate supply chains; risk that US budget fights and elections could affect the economy, financial markets

On Thursday, Fed’s Bostic sounded more dovish than expected as he indicated the start of rate cuts even before July if core inflation falls more than his expectation in the coming months. Subsequently, Wall Street Futures and Gold recovered, while USD stumbled.

Conclusions:

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)*(4.50.00-2.00) =0+2+2.50=4.50% (for 2024)

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 for CY23

Fed has to ensure a 2% price stability (core inflation) target keeping the unemployment rate below 4% and also 10Y bond yield below 5.00-4.50% so that borrowing cost for Uncle Sam remains manageable/sustainable to fund +34T debt (never-ending).

In any way, at the current run rate and trend, the average US core PCE inflation should be around +4.0% in 2023, +2.5% in 2024, +2.1% in 2025, and +1.5% in 2026, in line with Fed’s Dec’23 SEP. Similarly, the U.S. core CPI inflation average should be around +4.6% in 2023, +3.2% in 2024, +2.5% in 2025, and +1.8% in 2026.

If US core CPI indeed dips below +3.0% by May-June’24 and if it seems that the 2024 average core inflation will be around +3.2%, then the Fed may start cutting rates from July’24 and may cut cumulatively 75 bps at -0.25% pace till Dec’24 for a repo rate at 4.75%, so that core real rate continues to stand around +1.50%, in line with the present restrictive stance (5.50% repo rate-4.00% average core CPI for last 6M).

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut (dovish jawboning) from Mar’24 (Q1CY24) to ensure a soft landing while bringing down inflation. Also, whatever the narrative, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 15% of its revenue as interest on public debt against China/EU’s 5.5%.

As a result of higher bond yields around 4.50%-5.00% (for 10Y UST); i.e. lower bond prices, the Fed is now in deep MTM loss for its huge bond holding. Fed is also providing higher interest to banks & financials for reverse repo operation than it getting under repo operation; i.e. Fed’s NIM/NII is now negative and theoretically the Fed is in negative profit to the tune of -$130B. The same is also true for various banks & financials, most of which are now in deep MTM loss for higher bond yields; i.e. lower prices for their HTM bond portfolio holdings due to Fed hikes. The US10Y TSY market price fell from around $140 to $105 from Jan’20 (pre-COVID) to mid-Oct’23; i.e. a fall of almost -33% in around 4 years; it recently recovered to almost $113 levels.

This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price & financial stability and soft-landing. Fed has to bring down inflation to +2.0% targets by ensuring US 10Y bond yield below 4.50-5.00%, and an unemployment rate below 4.0% without triggering an all-out or even a brief recession in the US Presidential election year (Nov’24). The Fed will ensure that the US10Y bond yield is below 4.50-5.00% at any cost for lower borrowing costs for Uncle Sam (U.S.), everything being equal. Thus, overall Fed is methodically jawboning on both sides (hawkish/dovish) from time to time to achieve all its goals at the same time.

Considering all pros & cons, Fed may wait for core inflation data (average for core PCE and core CPI) for at least Dec’23-Mar’24 and if it goes down to around +4.00% from the projected 2023 average of +4.5% (4.80% core CPI and +4.20% core PCE), the Fed may cut rep rates/FFR by -25 bps in July; further if such disinflation trend continues, Fed may cut -25 bps each in September and December for a cumulative -75 bps.

We may see a synchronized global easing from H2CY24. As the Fed is the world’s unofficial central bank because the USD is the ‘King’ (the world’s most preferred FX or global reserve currency), all major G20 central banks are now bound to follow the Fed policy stance to maintain present policy/currency/bond yield parity, everything being equal.

Thus the market is now expecting a synchronized global easing (rate cuts) by major G20 global central banks including ECB, BOE, BOC, PBOC, and even India’s RBI, whatever may be the domestic macro-economic narrative (just like post-COVID synchronized global tightening to bring inflation down to targets).

Fed policymakers will now jawbone the market in a balancing way to keep the US10Y bond yield between the 3.25-5.25% range or around 4.00-4.50% on an average to maintain price/labor market/financial (Wall Street) and also Main Street/White House stability in the election year (2024). As the U.S. labor market is still robust with healthy wage growths, the incumbent Biden admin may prefer price stability and lower inflation in the coming months along with a sub/below 4% unemployment rate; i.e. price stability over GDP growths. As the 10Y bond is the main instrument for raising debt and a benchmark for US/global borrowing costs, the Fed may not allow it to hover above 5.00% for long under any circumstances, everything being equal. Fed needs to lower borrowing costs for the U.S. government from the present 15% to 10-7% over the next few years.

Fed hiked rate last in July’23 for a +5.50% repo rate and in hold mode with a hawkish stance since Aug’23; subsequently, US10Y bond yield gradually surged from around +3.75% to +5.00% by late November. As a result of higher borrowing costs and tighter financial conditions, the demand of the economy was affected to some extent, resulting in lower inflation. Now Fed has to keep on hold (neutral mode) for at least 10-12 months from July’23, so that the impact of higher borrowing costs is gradually transmitted to the real economy in full, resulting in core inflation back to targets.

Thus Fed has to wait till at least July’24 for the expected 1st rate cut; otherwise, its credibility may be at stake. If the US10Y bond yield again falls below +3.0% in the coming days (from the present +3.95%), then it may cause less restrictive financial conditions, resulting in higher core inflation. Thus Fed has to jawbone the market so that the US10Y bond yield hovers around 4.0-4.50% in the coming days so that the Fed can ensure relatively lower borrowing costs and price stability (soft landing).

Market wrap:

On Thursday, Wall Street Futures surged on tech boost and less hawkish talks by Fed’s Bostic. Blue Chip DJ-30 surged +0.55%, tech-heavy NQ-100 soared +1.35%, while broader SPX-500 gained +0.88%. Wall Street was boosted by techs, communication services, industrials, consumer discretionary, materials, banks & financials, and healthcare, while dragged by utilities, real estate, energy, and consumer staples. Dow Jones was boosted by Boeing (large order from India), Apple (analyst upgrade), Walt Disney, Intel, Walmart, Caterpillar and Microsoft.

In the early Thursday European session, US/European stock Futures got some boost on suspected buying action by the Chinese PPT (Plunge Protection Team) to support the Chinese stock market. Also, A positive earnings report from Taiwan semiconductor giant TSMC was boosting AMD, NVDA (NVIDIA) and other chip stocks. TSMC, which is the main supplier to Apple and Nvidia, said it expects a return to solid growth this quarter. Boeing also gained after winning an order for 150 of its troubled 737 Max jets from India’s newest airline. But overall risk trade was also undercut amid the competition of ‘surgical strike’ with jets/missiles between Pakistan and Iran to destroy each other’s terror network!

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

Whatever may be the narrative, technically Dow Future (37650), now has to sustain over 37800 levels for a further rally to 38000/38200 and further 38700/39000-39200/39500 levels in the coming days; otherwise, sustaining below 38050-37500-37350 levels may further fall to 37280*-37200/37000-36850/36650 and 36400/36200-36050/36000-35800*/35500 and may further fall to 35350/35250-35000/34800 and 34650/34120-34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (17115) now has to sustain over 17300 for a further rally; otherwise, sustaining below 17200/17100-17000/16850 may again fall to 16550/16300-16200/16050 and 15700/15400, and further 15100-14140 in the coming days.

Also, technically Gold (XAU/USD: 2022) now has to sustain over 2030 for a further rally to 2040-2050-2062-2085-2105/2120 and 2130/2152 levels; otherwise sustaining below 2025, may again fall to 2010-2000-1990-1975-1960/1940 in the coming days.