Wall Street, Gold surged on hopes of an early Fed rate cuts

·        Gaza war tensions also helped Gold; the latest initial jobless claims surged, but continuous jobless claims indicate a 3.8% average US unemployment rate

Wall Street Futures were almost flat for the last few days amid hopes & hypes of an early Gaza war ceasefire and Fed pivot coupled with mixed economic data and earnings/guidance report card and hawkish Fed talks. But on Thursday, Wall Street Futures and gold surged on renewed hopes of an early Fed rate cut after hotter-than-expected initial jobless claims. Gold was also boosted by lingering geopolitical tensions over the Gaza war. Also, lower USD as a result of less dovish BOE hold and upbeat UK GDP data helped gold.

On Thursday, Fed’s Cook said:

·         The Fed's discount window efficiency can be improved

·         The treasury market has still functioned well

·         The treasury market liquidity levels have been somewhat low recently

·         Households remain resilient but watching rising delinquency rates

·         The overall risk from CRE is considered “sizable but manageable”

·         Financial firms well positioned to absorb shocks; supervisors working with firms that have seen fair-value losses from high rates and those with large commercial real estate exposure

·         Households remain resilient but I am watching rising delinquency rates

·         Growth of private credit likely has not hurt the financial system's resilience, the sector appears well-positioned to hold the riskiest corporate credit

·         Firms have ample earnings to cover debt payments

On Thursday, Fed’s Collins said:

·         The Fed would not use AI to conduct monetary policy

·         The markets have already priced in Fed balance sheet actions

·         The very strong jobs market has bolstered consumer spending

·         It is too soon to tell just how restrictive policy is

·         Holding rates steady for longer will slow the economy

·         The current monetary policy should slow the economy

·         A very strong jobs market has bolstered consumer spending

·         Expects demand will need to slow to get inflation to 2%

·         I am optimistic that the Fed can get 2% inflation in a reasonable time frame

·         The economy is robust; the job market is coming into better balance

·         Fed policy is well-positioned for the current outlook

·         Monetary policy is ‘moderately’ restrictive

·         I don’t expect the productivity jump to be persistent

·         There are risks to cutting rates too soon

·         Firms are well-positioned to absorb faster wage growth

·         Recent inflation setbacks are not a surprise

·         I expect demand will need to slow to get inflation to 2%

U.S. Initial Jobless Claims Surge to Over 8-Month High:

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) increased to 231K in the week ending 4th May from 209K in the previous week, above market expectations of 210K and highest in the last 8-months (since Aug’23).

As per some state comments, the increase in initial jobless claims is due to layoffs in construction, manufacturing, administrative & support (back office), waste management, and remediation services industries.

The 4-week moving average of initial jobless claims, a better indicator to measure underlying data, as it removes week-to-week volatility, also increased to 215K on the week ended 4th May from 210.25K in the previous week and the highest since Feb’24.

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), increased to 1785K in the week ending 27th April, from 1768K in the previous week, lower than the market expectations 1790K. The 4-week moving average was 1781K, from the previous week's average of 1787.25 K. The advance seasonally adjusted insured unemployment rate was unchanged at 1.2%. The continuing jobless claims number is a proxy for the advance numbers of seasonally adjusted insured unemployed persons for the 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). The latest continuing jobless claims are still elevated which may be an indication of some softening in the labor market amid a difficult macroeconomic and geopolitical (external trade) environment coupled with higher borrowing costs and the deluge of tech layoffs (amid generative AI narrative).

Overall, as per seasonally unadjusted continuing jobless claims under all categories (UI) of around 1808K (2-week rolling average) and assuming average uninsured employees (not getting any UI benefit) of around 4600K (against prior average 4000K), estimated unemployed persons would be around 6408K in May’24 against 6491K sequentially. Further, if we assume the labor force is around 168307K, the unemployment rate would be around 3.8% in May’24 from 3.9% sequentially. The estimated number of employed persons would be around 161799K in May’24, an addition of around +308K sequentially against +25K in Apr’24 (as per Household survey). In brief, we may see better US NFP/BLS job data in May’24 after ‘terrible’ Apr’24.

 

 

Conclusions:

The 6M rolling average of the US unemployment rate is now around +3.8%, while core CPI inflation is around +3.9%; i.e. US core CPI inflation is still substantially above the Fed’s +2.0% targets, while unemployment rate is still below the Fed’s 4.0% red line. Thus Fed has still space for a higher longer policy stance (restrictive) to produce additional slack in the economy, so that underlying demand decreases further to some extent to match the present supply capacity of the economy, bringing inflation down towards +2.0% targets on a sustainable basis. Fed now needs more confidence for the disinflation process, which is now almost stalled after a good pace in H2CY23.

Also, looking ahead, the Fed may keep B/S size around $6.60-6.50T, around pre-COVID levels and 22% of estimated CY25 nominal GDP around $30T to ensure financial/Wall Street stability along with Main Street stability; i.e. price and employment stability. Fed’s B/S size is now around $7.40T and by May’24, it should be around $7.30T. At around the projected QT rate of $0.04T/M, it may take 18 months from June’24 to reach the targeted Fed B/S size of around $6.60T; i.e. by Dec’25, Fed’s QT may end with the B/S size around $6.60-6.50T.

Rate cuts along with QT (even with a 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 anti-incumbency wave (dissatisfaction) among general voters against Biden admin (Democrats) on some economic issues (higher cost of living).

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 cut 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/proper 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 5.00% at any cost (against present levels of average core CPI around +4.0%).

But the Fed may also blink on rate cuts in H2CY24 just before the US election to keep itself politically independent/impartial/neutral:

Ahead of Nov’24 US Presidential election, as seen in the Mar’24 Congressional testimony, Fed/Powell is under huge pressure from opposition Republican lawmakers (Trump & Co) to support Biden & Co (Democrats) in boosting the election prospect by facilitating rate cuts just before the Nov’24 election. Thus Fed may not go for any rate cuts till Nov’24 or even Dec’24 to show that it’s politically independent/neutral.

The most logical step would be Fed to close the QT completely before going for a rate cuts cycle and then go for any QE, if required to counter another economic crisis down the years. Fed has to prepare its B/S for the next round of QQE to face another cycle of financial crisis and thus has to normalize the B/S first. Presently, it seems that the Fed is not so confident about the QT pace, which may trigger another QT tantrum, as we have seen in late 2019.

Fed is ‘extremely’ worried about the pace of slower disinflation. Fed is also apparently confused about the dual combination of QT, even at a slower pace (QT taper) and rate cuts in the months ahead as these two instruments (tools) are contradictory/opposite (like if Fed goes for QE and rate hikes at the same time). Ideally, the Fed should finish the QT first for a proper B/S size (bank reserve) to ensure ample liquidity for the US funding/money/REPO market.

But the 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. Bank of Canada (BOC), recently clarified as long as the policy rate remains within the sufficiently restrictive zone, BOC may go for limited rate cuts, along with QT (even at a reduced pace) as QT is itself equivalent to rate hikes to some extent (tighter banking/funding/money market liquidity). If the real policy rate falls into the stimulative zone, then BOC may go for more rate cuts and completely close or at least temporarily close the QT. BOC is the smaller proxy of the Fed and may have more academic clarity regarding its policy actions.

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%. But after Powell’s remarks, it seems that the Fed may not cut thrice in 2024 from Sep’24 and may cut only once (symbolic) in Dec’24 or may not cut at all in 2024.

The market is now expecting 3-1 rate cuts (75-50 bps) in 2024, while some Fed policymakers are now arguing for lesser rate cuts of 1-2 rate cuts or even no rate cuts at all. Looking ahead, the Fed may not cut rates at all in 2024 considering the slower rate of disinflation, political issues ahead of the Nov’24 election, and the logic that it should not go for any rate cuts while doing QT, which is the opposite. Also, the reduction of B/S from around $8.97T to around $6.60T (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).

In that scenario, if the US core CPI average for 2024 comes down to around +3.00% by Dec’24 from present levels of +3.8%, the Fed may cut rates by -100 bps in 2025 for a repo rate +4.50% (from present +5.50%) for a real restrictive repo rate +1.50% (repo rate 4.50%-3.00% projected average core CPI for 2024). Presently, the real restrictive repo rate is also around +2.00% (repo rate 5.50%-3.50% average 6M core inflation).

At present, in its last (Mar’24) SEP/dot-plots, the Fed projected -75 bps rate cuts each in 2024, 2025, and 2026 and -50 bps rate cuts in 2027 for a terminal neutral repo rate +2.75% against pre-COVID neutral repo rate +2.50%. Now various Fed policymakers are arguing for a slightly higher neutral repo rate at +3.00% against projected core CPI of +2.00%; i.e. neutral real rate at +1.00%.

Thus depending upon the actual trajectory of core CPI, the Fed may cut -100 bps each in 2025, 2026, and -50 bps in 2027 for a terminal neutral repo rate of +3.00% from the present +5.50%. 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.

Although, the Fed’s official QT rate is -$0.095T/M ($90B/M), in reality, the effective average QT rate is already around -$0.073T/M. As the Fed is now managing the funding/money market through ON/RRP, there is a lower risk of a 2019 type of QT tantrum this time.

Fed’s mandate is now 2% price stability (core inflation), below 4% unemployment rate, and below 4.75-5.00% US 10Y bond yield to ensure lower borrowing costs for the government and overall financial stability. Fed, as well as ECB, BOE, and BOC, are now struggling to keep bond yield and inflation at their preferred range despite non-stop jawboning; perhaps they are talking too much too early and thus FX market is not being influenced by them significantly, moving in a narrow range. The BOJ is now trying to talk down the USDJPY desperately, presently hovering around 152 levels, causing higher imported inflation and a higher cost of living back home, although it may be beneficial for exports. However, most of the Japanese are not happy at all due to higher imported inflation in Japan for the devalued currency.

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.5%. 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. The Fed wants to keep the real/neutral rate around +1.0% in the longer term (assuming a +3.0% repo rate and +2.0% core inflation). But in the meantime, till core inflation/headline inflation goes down to around 2.00%  on a sustainable basis, the Fed wants to maintain the real rate at around present restrictive levels of 1.00-2.00% (assuming the present repo rate 5.50% and 2023 average core inflation around 4.50% and present 6M rolling average of core inflation around 3.50%). Fed needs a +2.00% restrictive real rate for 2024 or at least H1CY24 to produce sufficient slack in the economy, so that core inflation falls to +2.0% target on a sustainable basis.

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%

Less likely: 1st scenario: 75 bps rate cuts each in 2024, 2025, 2026, and -50 bps in 2027 for a neutral repo rate of +2.75%

More likely 2nd scenario: -100 bps rate cuts each in 2025, 2026, and -50 bps in 2027 for terminal neutral reo rate +3.00%

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. Fed may continue the QT (even at an officially slower pace) and rate cuts at the same time despite being contradictory. Fed may say (like BOC) that as long as the policy rate is in the restrictive zone (say 1.50-2.00% above core inflation), the Fed may continue both rate cuts and QT to reduce overall restrictiveness. When the policy rate moves into a neutral/stimulative zone, say 50 bps above average core inflation, then the Fed may go for more rate cuts and close the QT.

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. 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 goes for -75 bps rate cuts in H2CY24, while the Fed goes for 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 inflation/economic narrative/jawboning.

Market impact:

On Thursday, Wall Street Futures and gold surged, while the USD slumped on renewed hopes of an early Fed rate cut (from September 24) after hotter-than-expected initial jobless claims data. Wall Street was boosted by almost all major sectors except techs. The US stock market was boosted by real estate, utilities, energy, materials, industrials, health care, consumer staples, banks & financials, consumer discretionary, and communication services, while dragged by techs. Script-wise, Wall Street was boosted by Home Depot, Caterpillar, Goldman Sachs, Amgen, Chevron, Apple, Amazon and Boeing, while dragged by Salesforce, IBM, Cisco, Nike, Airbnb and McDonald’s.

Bottom line: Summary

·         Fed may not cut rates before Nov’24 US election

·         Fed may not cut rates at all from Sep’24, just months before Nov’24 US election to avoid any political controversy, and may/may not cut rates in Dec’24; Fed may revise dot-plots in June meeting.

·         At present, Fed’s Mar’24 dot-plots show: 75 bps rate cuts each in 2024, 2025, 2026, and -50 bps in 2027 for a neutral repo rate of +2.75%

·         But the Fed may now show the June’24 dot-plots as -100 bps rate cuts each in 2025, 2026, and -50 bps in 2027 for terminal neutral repo rate +3.00%

·         Another scenario: Fed may also cut -50 bps in Dec’24 or even in Jan’25 after the Nov’24 US election to avoid any political controversy and also to assess overall inflation and employment data for the whole of 2024.

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

Whatever may be the narrative, technically Dow Future (38900), now has to sustain over 39200 for a further rally to 39300/39400-39500/39750* and 40000/40200-40425/40600-40700-42600 levels in the coming days; otherwise, sustaining below 39100/39000-38900, DJ-30 may again fall to 38700/500-38300/38050-37650/37450*, and further fall to 37300*/37200-37050/36600 and 36300/36300 and even 35700 levels in the coming days.

Similarly, NQ-100 Future (18200) now has to sustain over 18400 for any recovery/rally to 18600/18750-18800/18900*-19100/19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18350-18200 may fall to 18100/18000 and 17800/17700-17600-17500 and 17400/17300-17100/17000* and 16890/16700-16595*-16100/15900 in the coming days.

Also, technically Gold (XAU/USD: 2315) now has to sustain over 2355 for a further rally to 2375*/2385-2395 and 2400/2410-2425/2435* to 2455-2475/2500; otherwise sustaining below 2345-2335, Gold may again fall to 2305/2290-2270 and 2255/2235*, and 2180/2145*, and further to 2120*/2110-2100/2080-2060/2039 and 2020/2010-2015 in the coming days.