Wall Street recovered from FOMC minutes panic low

Wall Street Futures were already under stress Tuesday despite Chinese stimulus on the concern of hawkish FOMC minutes and subdued report card from AI chip maker NVIDIA (to be released Wednesday). There was also a report that Microsoft may be making AI server gear (networking card) to cut NVIDIA dependence. On Thursday, all focus of the market was on FOMC minutes and NVIDIA report card. Overall the market is now gradually discounting 75-100 bps rate cuts in 2024 from June-July’24 and the Fed is preparing the market for the same, most probably going for rate cuts from July’24 and by 75 bps unless there is an unusual deflation/dis-inflation and some serious concern about employment situation.

Highlights of FOMC minutes-(31st January):

·         A couple of policymakers pointed to downside risks from maintaining an overly restrictive stance for too long

·         Fed officials judged the policy rate likely at its peak for this cycle

·         Most Fed policymakers noted the risks of easing too quickly and emphasized the importance of incoming data in judging if inflation is moving sustainably to 2%

·         Some officials noted progress on inflation could stall

·         Policymakers generally noted they did not see it as appropriate to lower the funds rate until gaining greater confidence in inflation moving sustainably toward 2%

·         While risks to achieving dual-mandate goals were in better balance, officials said they remained highly attentive to inflation risks

·         Several policymakers emphasized the importance of communicating clearly about the data-dependent approach

·         A few officials noted balance sheet runoff could continue after rate cuts begin

·         Staff economic outlook was slightly stronger than the December projection

·         Officials highlighted uncertainty around how long a restrictive policy stance would be needed

·         Noting reductions in overnight reverse repo usage many officials said it would be appropriate to start in-depth balance sheet discussions at the next meeting

·         Fed staff saw risks to the economic forecast skewed to the downside

·         Fed staff characterized US financial system vulnerabilities as notable

·         Staff placed some weight on the chance that further progress on lowering inflation could take longer than expected

·         some policymakers said slowing the pace of balance sheet runoff could help smooth the transition to an ample level of reserves, and could allow balance sheet runoff to continue for longer

Full text of relevant section of FOMC minutes:

Staff Economic Outlook

The economic forecast prepared by the staff for the January meeting was slightly stronger than the December projection, as the upward revision to the 2023 GDP growth implied by incoming data boosted the level of output throughout the projection period. The lagged effects of earlier monetary policy actions, through their continued contribution to tight financial and credit conditions, were still expected to push output growth in 2024 and 2025 below the staff's estimate of potential growth; in 2026, output was expected to rise in line with potential. The projected path for the unemployment rate was revised down slightly, reflecting the upward revision to the level of output.

Total and core PCE price inflation were both projected to step down in 2024 as demand and supply in product and labor markets moved into better alignment. By 2026, total and core PCE price inflation were expected to be close to 2 percent.

The staff continued to view the uncertainty around the baseline projection as elevated but noted that this uncertainty had diminished substantially over the past year. Risks around the inflation forecast were seen as tilted slightly to the upside; al­though inflation had come in close to expectations throughout most of 2023, the staff placed some weight on the possibility that further progress in reducing inflation could take longer than expected.

The risks around the forecast for real activity were viewed as skewed to the downside, as any substantial setback in reducing inflation might lead to a tightening of financial conditions that would slow the pace of real activity by more than the staff anticipated in their baseline forecast. In addition, the possibility of a larger-than-expected erosion of households' financial positions was seen as a downside risk to the projection for real activity.

Participants' Views on Current Conditions and the Economic Outlook

“In their discussion of current economic conditions, participants noted that recent indicators suggested that economic activity had been expanding at a solid pace. Real GDP growth in the fourth quarter of last year came in above 3 percent at an annual rate, below the strong growth posted in the third quarter but still above most forecasters' expectations. Participants observed that the unexpected strength in real GDP growth in the fourth quarter reflected stronger-than-expected net exports and inventory investment, which tend to be volatile and may carry little signal for future growth.

Still, consumption continued to grow at a solid pace. In addition to strong demand, many participants attributed the recent expansion in economic activity to favorable supply developments. Participants noted that the pace of job gains had moderated since early last year but remained strong and that the unemployment rate had remained low. Inflation had eased over the past year but remained elevated.

Regarding the economic outlook, participants judged that the current stance of monetary policy was restrictive and would continue to put downward pressure on economic activity and inflation. Accordingly, they expected that supply and demand in product and labor markets would continue to move into better balance. In light of the policy restraint in place, along with more favorable inflation data amid ongoing improvements in supply conditions, participants viewed the risks to achieving the Committee's employment and inflation goals as moving into better balance. However, participants noted that the economic outlook was uncertain and that they remained highly attentive to inflation risks.

In their discussion of inflation, participants observed that inflation had eased over the past year but remained above the Committee's 2 percent inflation objective. They remained concerned that elevated inflation continued to harm households, especially those with limited means to absorb higher prices. While the inflation data had indicated significant disinflation in the second half of last year, participants observed that they would be carefully assessing incoming data in judging whether inflation was moving down sustainably toward 2 percent.

Participants noted improvements in both headline and core inflation and discussed the underlying components of these series. Al­though total PCE inflation in December remained above the Committee's 2 percent objective on a 12-month basis, on a 6-month basis, total PCE inflation was near 2 percent at an annual rate, and core PCE inflation was just below 2 percent. Participants judged that some of the recent improvements in inflation reflected idiosyncratic movements in a few series.

Nevertheless, they viewed that there had been significant progress recently on inflation returning to the Committee's longer-run goal. Many participants indicated that they expected core non-housing services inflation to gradually decline further as the labor market continued to move into better balance and wage growth moderated further.

Various participants noted that housing services inflation was likely to fall further as the deceleration in rents on new leases continued to pass through to measures of such inflation. While many participants pointed to disinflationary pressures associated with improvements in aggregate supply—such as increases in the labor force or better productivity growth—a couple of participants judged that the downward pressure on core goods prices from the normalization of supply chains was likely to moderate.

Participants observed that longer-term inflation expectations had remained well anchored at a level consistent with the Committee's 2 percent inflation objective. Measures of near-term inflation expectations had also declined recently, in some cases to within their ranges in the years before the pandemic. Some participants pointed to reports from contacts that firms could not as easily pass on price increases to consumers or were making less frequent price adjustments than they had in recent years.

In their discussion of the household sector, participants observed that consumer spending had been stronger than expected, supported by low unemployment and solid income growth. A number of participants judged that consumption growth was likely to moderate this year, as growth in labor income was expected to slow and pandemic-related excess savings were expected to diminish.

In addition, some participants noted signs that the finances of some households—especially those in the low- and moderate-income categories—were increasingly coming under pressure, which these participants saw as a downside risk to the outlook for consumption. In particular, they pointed to increased usage of credit card revolving balances and buy-now-pay-later services, as well as increased delinquency rates for some types of consumer loans.

The reports of business contacts cited by participants varied across industries and Districts. In a few Districts, contacts reported that the pace of economic activity was steady or solid, while in several others, contacts expressed increased optimism about the economic outlook and prospects for investment. District reports from manufacturers were mixed, as some contacts saw increased activity, whereas others saw subdued or weakening activity.

A couple of participants noted that al­though soft commodity prices and elevated borrowing costs had contributed to a decline in farm incomes recently, agricultural land values remained resilient, and delinquencies on farm loans continued to be low. A few participants remarked that financing and credit conditions were particularly challenging for small businesses.

Participants noted that the labor market remained tight, but demand and supply in that market had continued to come into better balance. Payroll growth had remained strong in the last few months of 2023 but had slowed from its pace seen a year ago, while the unemployment rate remained low.  Participants also observed that the ratio of job openings to unemployed workers had declined over the past year but remained somewhat above its pre-pandemic level.

Consistent with a reduction in labor market tightness, business contacts in several Districts reported an easing in wage pressures or an increased ability to hire and retain workers. Participants mentioned several developments that had boosted labor supply last year, including higher labor force participation, immigration, and an improved job-matching process; however, a few participants judged that further increases in labor supply may be limited, pointing, for instance, to the decline in labor force participation in December. While labor market conditions were generally seen as strong, several participants noted that recent job gains were concentrated in a few sectors, which, in their view, pointed to downside risks to the outlook for employment.

Participants discussed the uncertainty surrounding the economic outlook. As an upside risk to both inflation and economic activity, participants noted that momentum in aggregate demand may be stronger than currently assessed, especially in light of surprisingly resilient consumer spending last year. Furthermore, several participants mentioned the risk that financial conditions were or could become less restrictive than appropriate, which could add undue momentum to aggregate demand and cause progress on inflation to stall.

Participants also noted some other sources of upside risks to inflation, including possible disruptions to supply chains from geopolitical developments, a potential rebound in core goods prices as the effects of supply-side improvements dissipate, or the possibility that wage growth remains elevated. Downside risks to inflation and economic activity noted by participants included geopolitical risks that could result in a material pullback in demand, possible negative spillovers from lower growth in some foreign economies, the risk that financial conditions could remain restrictive for too long, or the possibility that a weakening of household balance sheets could contribute to a greater-than-expected deceleration in consumption. A few participants mentioned the possibility that economic activity could surprise the upside and inflation to the downside because of more favorable-than-expected supply-side developments.

In the discussion of financial stability, participants observed that risks to the banking system had receded notably since last spring, though they noted vulnerabilities at some banks that they assessed warranted monitoring. These participants noted potential risks for some banks associated with increased funding costs, significant reliance on uninsured deposits, unrealized losses on assets resulting from the rise in longer-term interest rates, or high CRE exposures.

Participants judged that liquidity in the financial system remained more than ample and discussed the importance of considering liquidity conditions as the Federal Reserve's balance sheet continues to normalize. While participants noted that they were not seeing any signs of liquidity pressures at banks, several participants noted that, as a matter of prudent contingency planning, banks should continue to improve their readiness to use the Federal Reserve's discount window, and that the Federal Reserve should continue to improve the operational efficiency of the window.

In addition, some participants commented on the difficulties associated with banks relying on some forms of private wholesale funding during times of stress. A few participants remarked on the importance of measures aimed at increasing the resilience of the Treasury market. A few participants noted cyber risks and the importance of firms being able to recover from cyber events. A few participants also commented on the financial condition of low- and moderate-income households who have exhausted their savings, as well as the importance of monitoring data on rising delinquencies on credit cards and autos.

In their consideration of appropriate monetary policy actions at this meeting, participants noted that recent indicators suggested that economic activity had been expanding at a solid pace. Job gains had moderated since early last year but remained strong, and the unemployment rate had remained low. Inflation had eased over the past year but remained elevated. Participants also noted that the risks to achieving the Committee's employment and inflation goals were moving into better balance and that the Committee remained highly attentive to inflation risks. Participants continued to be resolute in their commitment to bring inflation down to the Committee's 2 percent objective.

In light of current economic conditions and their implications for the outlook for economic activity and inflation, as well as the balance of risks, all participants judged it appropriate to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent at this meeting. All participants also judged it appropriate to continue the process of reducing the Federal Reserve's securities holdings, as described in the previously announced Plans for Reducing the Size of the Federal Reserve's Balance Sheet.

Participants viewed maintaining the current stance of policy as appropriate given the incoming data, which indicated that inflation had continued to move toward the Committee's 2 percent objective and that demand and supply in the labor market had continued to move into better balance. Participants commented that maintaining the target range for the federal funds rate at this meeting would promote further progress toward the Committee's goals and allow participants to gather additional information to evaluate this progress.

In discussing the policy outlook, participants judged that the policy rate was likely at its peak for this tightening cycle. They pointed to the decline in inflation seen during 2023 and to growing signs of demand and supply coming into better balance in product and labor markets as informing that view. Participants generally noted that they did not expect it would be appropriate to reduce the target range for the federal funds rate until they had gained greater confidence that inflation was moving sustainably toward 2 percent.

Many participants remarked that the Committee's past policy actions and ongoing improvements in supply conditions were working together to move supply and demand into better balance. Participants noted that the future path of the policy rate would depend on incoming data, the evolving outlook, and the balance of risks. Several participants emphasized the importance of continuing to communicate clearly about the Committee's data-dependent approach.

In discussing risk-management considerations that could bear on the policy outlook, participants remarked that while the risks to achieving the Committee's employment and inflation goals were moving into better balance, they remained highly attentive to inflation risks. In particular, they saw upside risks to inflation as having diminished but noted that inflation was still above the Committee's longer-run goal.

Some participants noted the risk that progress toward price stability could stall, particularly if aggregate demand strengthened or supply-side healing slowed more than expected. Participants highlighted the uncertainty associated with how long a restrictive monetary policy stance would need to be maintained.

Most participants noted the risks of moving too quickly to ease the stance of policy and emphasized the importance of carefully assessing incoming data in judging whether inflation is moving down sustainably to 2 percent. A couple of participants, however, pointed to downside risks to the economy associated with maintaining an overly restrictive stance for too long.

Participants observed that the continuing process of reducing the size of the Federal Reserve's balance sheet was an important part of the Committee's overall approach to achieving its macroeconomic objectives and that balance sheet runoff had so far proceeded smoothly. In light of ongoing reductions in usage of the ON RRP facility, many participants suggested that it would be appropriate to begin in-depth discussions of balance sheet issues at the Committee's next meeting to guide an eventual decision to slow the pace of runoff.

Some participants remarked that, given the uncertainty surrounding estimates of the ample level of reserves, slowing the pace of runoff could help smooth the transition to that level of reserves or could allow the Committee to continue balance sheet runoff for longer. In addition, a few participants noted that the process of balance sheet runoff could continue for some time even after the Committee begins to reduce the target range for the federal funds rate.”

Conclusions:

Fed may announce a plan for QT tapering in the March meeting and close the same by June before going for rate cuts from July’24. Fed, the world’s most important central bank, may not continue QT and rate cuts at the same time, which are contradictory.

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 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 quite robust) and not ready to cut rates early as it may again cause higher inflation just ahead of the election. Fed may hike only from July’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 and Real/Main Street.

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%. Thus some Fed policymakers like Goolsbee are trying to balance hawkish talks by sounding less hawkish /dovish in conjunction with overall less dovish/hawkish Fed talks to control the overall market (Wall Street), inflation expectations, and the most vital bond yield. It’s a well-planned jawboning strategy by the Fed in synchronization with ECB, BOE, and BOC to control the overall financial market and bring down inflation towards targets without causing an outright recession; i.e. soft & safe landing.

Fed may cut rates from July’24; i.e. in H2CY24 for a cumulative 75-100 bps; every major central bank including ECB, BOE, and BOC has to follow ‘King Fed/USD’, whatever may be the narrative (synchronized global rate cuts amid a synchronized easing in core inflation). In any way, as the Fed is not in a hurry to cut rates in H1CY24, expect generally hotter than expected US labor market data and gradual easing of core inflation data to suit the Fed narrative. The White House/Biden admin will also be happy going for the election supported by a strong economy, robust labor market, and cooling inflation almost at the 2% target.

Bottom Line:

Fed, ECB may also cut rates from July’24; i.e. in H2CY24 for a cumulative 75-100 bps (synchronized global rate cuts amid a synchronized easing in core inflation); every major central bank including PBOC has to follow ‘King Fed/USD’, whatever may be the narrative.

Market wrap:

On Wednesday, Wall Street Futures and Gold slipped to some extent after FOMC minutes showed the Fed may not go for any rate cuts in H1CY24, but soon recovered as overall FOMC minutes are in line with market expectations. Overall the market is now gradually discounting 75-100 bps rate cuts in 2024 from June-July’24 and the Fed is preparing the market for the same, most probably       going for rate cuts from July’24 and by 75 bps unless there is an unusual deflation/dis-inflation and some serious concern about employment situation. Additionally, Wall Street Futures were also boosted by NVIDIA amid earnings beat.

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

Whatever may be the narrative, technically Dow Future (38715), now has to sustain over 39200 levels for a further rally to 39500/39900-40200/40500 and even 42600  levels in the coming days; otherwise, sustaining below 39150/39000-38950/38600 levels may again fall to 38400/38200*-38000*/37300 levels in the coming days.

Similarly, NQ-100 Future (17745) now has to sustain over 17400 levels for any recovery to 18000-18200 and further towards 18500/18675-18975/19200 and 19450/19775-2000/20200 in the coming days; otherwise, 17290/17250 and 16750-16550 in the coming days.

Also, technically Gold (XAU/USD: 2025) now has to sustain over 2035-2055 for any further rally to 2067/2085-2100/2125-2130/2175; otherwise sustaining below 2030, may again fall to 2020/2010-2000-1995/1985-1975 and even 1950 may be on the card.