Wall Street, Gold stumbled on Fed’s higher for longer stance

On Friday, Wall Street Future surged to the session high after a softer expected sequential core PCE inflation headline, but soon stumbled on details and the fact that overall core inflation is still substantially higher than the Fed’s target for at least another +0.25 bps hike on 1st November for a terminal repo rate +5.75%. Fed’s Williams also indicated at least another hike for a restrictive repo rate of +5.75% and hold the restrictive rate for ‘some time’; i.e. till at least H1CY24.

Wall Street was also spooked by the concern of another government shutdown political soap opera. On late Saturday, the U.S. House led by Republican Speaker McCarthy passed the CR/stopgap funding bill by 335-91 votes and the U.S. Senate led by Democrat Majority Leader Schumer also passed the same at the last minute (late Saturday) by 88-9 votes, so that President Biden can sign it in time to avoid another government shutdown for scarcity of fund/exhaustion of borrowing (credit card) limits in the world’s biggest economy and most democratic country.

As usual, the latest CR bill was passed by the U.S. Congress after days of political soap opera. But the market was more or less confident about it and thus it was in expected line. Wall Street Futures got some boost early Monday Asian session but soon stumbled on growing political and policy paralysis with the U.S. economy coupled with the Fed’s higher for a longer stance to ensure a +2% price stability mandate sustainably.

The market is now concerned about subdued discretionary consumer spending amid the higher cost of living and elevated cost of borrowing along with slowing China. The corporate earnings may be significantly affected. The U.S. now needs targeted fiscal stimulus/reform to improve the supply capacity of the economy along with tighter monetary policy from the Fed to reduce demand of the economy, so that both supply demands balance each other for the required price stability without causing an all-out recession (hard landing).

On late Saturday (30th September), U.S. President Biden issued an official statement after the Passage of the Bipartisan Bill to Keep the Government Open (by increasing the credit card limit endlessly):

“Tonight, bipartisan majorities in the House and Senate voted to keep the government open, preventing an unnecessary crisis that would have inflicted needless pain on millions of hardworking Americans. This bill ensures that active-duty troops will continue to get paid, travelers will be spared airport delays, millions of women and children will continue to have access to vital nutrition assistance, and so much more. This is good news for the American people.

 But I want to be clear: we should never have been in this position in the first place. Just a few months ago, Speaker McCarthy and I reached a budget agreement to avoid precisely this type of manufactured crisis. For weeks, extreme House Republicans tried to walk away from that deal by demanding drastic cuts that would have been devastating for millions of Americans. They failed.

While the Speaker and the overwhelming majority of Congress have been steadfast in their support for Ukraine, there is no new funding in this agreement to continue that support. We cannot under any circumstances allow American support for Ukraine to be interrupted. I fully expect the Speaker will keep his commitment to the people of Ukraine and secure passage of the support needed to help Ukraine at this critical moment.”

The Biden admin so far helped Ukraine by above $43B officially (security assistance) to face the Russian war machine and opposition Republicans are now against further such assistance, which has no resolution in sight. But even if there was no Ukraine issue, Republicans were bound to oppose the increase of the U.S. credit/borrowing limit due to political compulsion and the same is also true for Democrats. In any way, on Monday, Wall Street was also undercut on the concern of further political uncertainty as some Republicans may move a motion to remove Speaker McCarthy as he is being seen as ‘Biden friendly’; in that scenario, Biden’s Democrats may have to vote for ‘trusted’ McCarthy to keep him as U.S. House Speaker in this political drama.

U.S. September Manufacturing PMI revised higher:

On Monday, the S&P Global final data showed that the U.S. Manufacturing PMI was revised higher to 49.8 in September, above the preliminary estimate of 48.9 and above August's reading of 47.9. The latest figure pointed to a fifth consecutive month of contraction in the sector's health, albeit only fractional. Output increased at a marginal pace that was nonetheless the fastest since May.

In contrast, job creation remained moderate, and new orders continued to decline for the fifth consecutive month, reflecting the impact of high-interest rates and inflation on consumer demand. On the price front, both input costs and output charges accelerated, though inflation rates remained historically low, well below the levels seen over the past three years. Moreover, business confidence reached its highest level since April 2022, driven by optimism about an impending improvement in demand conditions.

The S&P Global comments about U.S. Manufacturing PMI:

"September saw a welcome near-stabilization of business conditions in manufacturing, but a further increase in price pressures is a concern on the inflation front. Output reversed some of the loss seen in August as higher employment and improved supply availability helped factories fulfill backlogs of orders. Although the pace of production growth remains disappointingly subdued thanks to a further decline in new orders received during the month, notably from weak export markets, there are signs that the situation will improve as we head through to the end of the year.

Manufacturers’ expectations of future output have jumped to their highest for nearly one and a half years, supply conditions continue to improve, and the rate of order book decline has moderated considerably in recent months, in part due to fewer producers and customers reporting deliberate cost-focused inventory reduction policies.

Less encouraging was the news on the inflation outlook, as producers’ costs rose at the fastest rate for five months, largely on the back of higher oil prices. These increased costs are already feeding through to higher prices to customers, which will inevitably result in some renewed upward pressure on inflation.”

Overall, S&P Global is quite concerned about the resurgence of product/goods inflation amid higher cost of production due to elevated oil/energy prices even though the U.S. economy may be nearing the end of the manufacturing recession.

On Monday, the ISM data also showed improved U.S. manufacturing activities in September. The ISM/U.S. Manufacturing PMI rose to 49.0 in September from 47.6 sequentially, above market expectations of 47.8 and the slowest contraction in the U.S. manufacturing sector in ten months. Despite the softened slowdown, the data still pointed to nearly one year's worth of consecutive monthly contractions in US factory activity, underscoring the impact of higher borrowing costs from the Federal Reserve in the sector.

Despite declining for the 13th month, new orders fell at a significantly slower pace as the evolving supply chain environment drove customers to take on more projects. Consequently, production rebounded from August’s stagnation and grew the most since July 2022, also supported by the rapid depletion of backlogs. Employment was also solid and rebounded from 3 periods of contraction. In the meantime, the decline in prices fell for the fifth straight month, raising hopes of larger margins for manufacturers.

On Monday, Fed’s Bowman said:

·         I see a risk that high energy prices could reverse some of the recent progress on lowering inflation

·         I expect progress on inflation to be slow, given the current level of monetary policy restraint

·         The frequency and scope of recent data revisions complicate the task of projecting how the economy will evolve

·         I remain willing to support a rate increase at a future meeting if data indicates progress on inflation has stalled or is too slow to return it to 2% in a timely way

·         Regulators seem to be engaging in heavy-handed supervision of banks, they should consider if this approach is appropriate

·         Inflation remains too high

·         It will likely be appropriate to raise rates further and hold them at a restrictive level for some time

·         I see a risk that high energy prices could reverse some of the recent progress on lowering inflation

·         I expect progress on inflation to be slow, given the current level of monetary policy restraint

·         The frequency and scope of recent data revisions complicate the task of projecting how the economy will evolve

·         I remain willing to support a rate increase at a future meeting if data indicates progress on inflation has stalled or is too slow to return it to 2% in a timely way

·         Regulators seem to be engaging in heavy-handed supervision of banks, they should consider if this approach is appropriate

·         Inflation remains too high.

·         It will likely be appropriate to raise rates further and hold them at a restrictive level for some time

On Monday, Fed’s Chair Powell said in round table iteration:

·         The Fed's focus is on a healthy economy

·         Feds Harker: The Fed is working on stable prices and maximum employment: Powell agrees

·         As expansions get longer and longer, more wage gains go to the lower part of the income spectrum

·         The Fed's ambition is a sustained, strong labor market

·         The Fed's focus is on a healthy economy

·         As expansions get longer and longer, more wage gains go to the lower part of the income spectrum

·         The Fed's ambition is a sustained, strong labor market

On Monday, Fed’s Barr said:

·         Supervisors expect banks to be ready and willing to use the discount window

·         The most important question is how long rates stay high.

·         Monetary policy can't be indifferent to financial risks

·         I expect some further softening in the US labor market

·         I'm highly attuned to risks to both of the Fed's mandates

·         I see a higher probability than previously for a soft landing

·         The labor market is tight, but supply and demand are coming into better balance

·         My baseline projection is for below-potential GDP growth over the next year and further softening of the labor market

·         The full effects of past tightening are yet to come in the months ahead

·         The most important question is how long we will need to hold rates at a sufficiently restrictive level; I expect it will take some time

·         The most important question is not whether an additional rate hike is needed this year

·         We are at a point where we can proceed carefully on monetary policy

·         I agree with Powell that we can proceed carefully with rates

·         Generative AI could eliminate some jobs, and cause serious dislocation

·         Generative AI could potentially improve productivity growth, quickly

·         There seems to be the right kind of slowing in housing

·         Balance sheet runoff and the Fed's interest rate tool do not necessarily create conflict

·         We're not anywhere close to the lower-bound level for bank reserves

·         It is not clear that leverage ratio is the top strain in the Treasury market

·         Goods and housing services inflation is on the right path, downward

·         The amount of credit tightening we are seeing is less than what I feared in March

·         We will likely need to keep rates up for some time

·         We are likely at or near sufficiently restrictive levels of rates.

·         Supervisors expect banks to be ready and willing to use the discount window

·         The most important question is how long rates stay high

Market wrap:

On Monday, Wall Street Futures recovered from their panic low after Fed’s Brar sounded less hawkish than expected as he talked about careful steps/caution in the next hike. Dow Future slumped almost -74 points, while NQ-100 surged +0.7% and SPX-500 edged up. Wall Street was dragged by utilities, energy (lower oil), real estate, materials, industrials, financials, consumer staples and healthcare, while boosted by consumer discretionary, techs and communication services. Gold was undercut by higher USD/US bond yields after the Biden admin was successful in averting the U.S. shutdown. Also, higher than expected U.S. Manufacturing PMI and the resurgence of goods inflation affected risk trade sentiment; USD/US bond yield surged.

Conclusion:

The Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a final pause in Dec’23.

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%)

As there is no significant easing of core inflation, especially core service inflation, the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle. But, if core CPI inflation indeed eased further to below +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).

Looking ahead, oil prices may stay elevated in the coming months between $75-95 instead of the earlier $65-75 despite US efforts to bring more supply from, Mexico, Brazil, Iran, Iraq, and Venezuela. OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $90 will continue to boost energy/transportation/logistics costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $85 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.

The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.

Going by the present trend/run rate, the U.S. core CPI may fall to +3.8% by Dec’23 and +3.4% by Feb’24, which may keep the Fed to hold on rates at +5.7% till at least Aug’24 before going for any rate cuts -25 bps or even -50 bps each in Sep’24 and Dec’24. Fed would like to boost Wall Street as well as Main Street before Nov’24 U.S. Presidential election. Fed has to ensure a soft landing; i.e. price stability along with financial/Wall Street stability and Main Street stability.

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.

Overall, it seems that the White House would be quite happy if the Fed could bring back core inflation towards 2% on a durable basis, while keeping the unemployment rate below 4% ahead of Nov’24, the U.S. Presidential election. The Fed is itself eager to cut its losses by cutting rates. The U.S. 2Y bond yield is now hovering around +5.13% and may soon scale 5.25-5.50% in hopes of another +25 bps Fed rate hike for a terminal repo rate of +5.75%.

Bottom line:

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

Whatever may be the narrative, technically Dow Future (33633) now has to sustain above 33500 levels for any recovery to 33850/34000-34150/34250 and 34300/34555-34600/34825-35070/200-415/850 levels; otherwise, sustaining below 33450 may again fall to 33240/200-32500/31750 levels in the coming days.

Similarly, NQ-100 Future (15000) now has to sustain over 14600-550 levels for any recovery to 14925/15150-15325/15500 and 15750/900-16000/655 in the coming days; otherwise, sustaining below 14500 may further fall to 14300/175-100/13890 and 13650-13125 levels.

Gold (XAU/USD: 1829) now has to sustain above 1843-1837 for any recovery to 1867/1875-1885/1900 and 1910/1920-1926/1937 and 1952/1970 levels; otherwise, sustaining below 1835, may further fall to 1825/1813*-1798/1770 level in the coming days.