Dow and gold surged on hopes of Fed rate and Trump tax cuts

·         Risk trade also getting a boost as Trump is leading 1% higher than Harris in opinion polls; the market is still discounting the Sep’24 Fed rate cut

·         But overall US core PCE/CPI inflation trajectory for Q1 & Q2CY24 may keep the Fed in ‘wait & watch’ mode till at least Sep’24 (Q3CY24)

On Thursday, Wall Street Futures initially surged, while Gold, Silver, and Oil slumped on hopes & hypes of an imminent Gaza war ceasefire, but reversed to some extent in the last hour of trading as Israel complained deal chances dented after US VP Harris vows to speak out on Gaza’s woes. Also, hotter than expected US GDP growth reading in Q2CY24 may be indicating Fed may afford to wait & watch for at least another quarter (Q3CY24) before going for the 11-QTR rate cuts cycle from Dec’24 (after the US election Nov’24, which may also clear the fiscal stance of the incumbent government); soft landing optimism also boosted DJ-30.

On Friday, some focus of the market was on U.S. Core PCE inflation, the Fed’s preferred gauze to measure underlying inflation trends. The BEA flash data showed U.S. annual (y/y) core PCE inflation (Seasonally Adjusted-SA) for June was unchanged at +2.6% from +2.6% sequentially, above the market expectations of +2.5% and remained at its lowest since Mar’21 (three years). The US core PCE inflation eased to +2.6% in May after being stalled at +2.8% in the last three months (Feb+Mar+Apr’24).

On a sequential (m/m) basis (seasonally adjusted) the U.S. core PCE inflation increased to +0.2% in June from +0.1% in May and above expectations of +0.1%.

In June’24, the U.S. super core PCE service inflation ex Housing/Shelter, (the current focus of the Fed) was unchanged at +3.4%, while the sequential rate was ticked up to +0.2% from prior +0.1%.

Also, annual PCE inflation eased to +2.5% in June’24 from +2.6% sequentially, while goods inflation continues in negative territory at -0.2% from -0.1% and service inflation also ticked down to +3.9% from +4.0% recorded in the prior three months.

The Fed is now also watching Dallas Fed Trimmed Mean Inflation, which was +2.8% in June’24 against +2.9% sequentially.

Overall, after the latest revisions, the 6M rolling average (6MRA) of US core PCE inflation was around +2.8% in June’24 against +4.1% yearly average for 2023, while Q2CY24 average was around +2.7% vs Q1CY24 average +2.9%. The 6MRA of US sequential core PCE inflation was around +0.3% in Jun’24; i.e. an annualized rate of +3.3%. The pace of disinflation in US core PCE inflation has been slowed down from the pace of H2CY23 (3.8% vs 3.2%) but is in line with H1CY24 (4.8% VS 4.6%). Thus Fed may look at least another quarter of data (Q3CY24) before gaining the required full confidence for launching the rate cuts cycle from Dec’24. The Fed is now gaining confidence incrementally, but not sufficient enough to go for rate cuts.

The Fed usually goes by a 6M rolling average (6MRA) of core PCE + core CPI inflation for any important policy move. As per the new series (2017 constant prices), the 6MRA core PCE inflation is now around +2.8% in June (vs +2.8% in the previous report), while the 6M rolling average of U.S. core CPI inflation is now around +3.6% (vs +3.7% in the previous report); i.e. 6M rolling average of US core inflation (CPI+PCE) is now around +3.2% (vs +3.3% in the previous report), still far above Fed’s +2.0% targets, but not very much above ideal 2.8-2.6% ‘full confidence building’ levels.

As per the present trend (R/R), Q3CY24 average US core inflation (CPI+PCE) at +2.9% by the Oct’24 report (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 (avoiding any political controversy).

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 +4.4% (for 2023), which is now around +3.2% in 2024 (6MRA). 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 due to increasing Gaza and Ukraine war tensions (Israel-Hezbollah/Lebanon/Iran). Also, Putin may hatch a ‘conspiracy’ against the Biden-Harris admin ahead of the US election as Putin may be favoring ‘friendly Trump’.

In the US, Core CPI (Consumer Price Index) and Core PCE (Personal Consumption Expenditures) are two different measures of inflation used to gauge price changes in the economy as well as any change in consumer consumption behavior after any meaningful change of prices (excluding food and energy prices due to their volatility).

The key differences between US Core CPI and Core PCE inflation are:

·         Core CPI measures the change in the prices of a fixed basket of goods and services purchased by households (out of pocket), while Core PCE measures the change in prices of variable goods and services consumed by individuals, both excluding food and energy

·         Core CPI focuses on the price changes of a fixed basket of goods and services typically consumed by urban households, while Core PCE has a broader scope, including all goods and services consumed by households, and adjusts for changes in consumer behavior in line with any significant changes in price (e.g., substitution effects)

·         The Core PCE, on the other hand, includes a broader range of expenditures. It accounts not only for out-of-pocket expenses but also for various goods and services paid for by third parties, such as employer-provided health insurance. This means that the PCE captures a wider array of consumer spending and includes expenditures by non-profit institutions as well.

·         The CPI uses a specific Laspeyres formula, which is based on a fixed basket of goods. This means it does not adjust for changes in consumer behavior in response to price changes. For example, if the price of beef rises, the CPI does not account for consumers switching to chicken.

·         The PCE employs a Fisher ideal index formula, which allows for substitutions between items as their relative prices change. This flexibility typically results in a smoother inflation rate, as it reflects changing consumer preferences more accurately. For example, if the price of beef rises, the CPI does not account for consumers switching to chicken, but the PCE does

·         The weights assigned to different categories in the CPI are based on a fixed survey of consumer spending patterns. These weights are updated less frequently, which can lead to discrepancies over time as consumer behavior shifts.

·         The PCE updates its weights more regularly based on current expenditure data, reflecting more recent consumer spending habits. This results in a more dynamic representation of inflation as it adapts to changes in consumption patterns.

·         Historically, the Core CPI tends to report higher inflation rates compared to the Core PCE. For instance, since 2000, the average annual PCE inflation has been about 0.4% points lower than that of the CPI. This difference can be attributed to the broader scope and more adaptive nature of the PCE, which captures the effects of consumer substitution more effectively.

·         Both the Core CPI and Core PCE are essential for understanding inflation trends in the U.S. economy.

·         The Fed prefers Core PCE because it provides a more comprehensive view of inflation and better captures changes in consumer behavior.

Moreover, several US Senators/Congress members, both Democrats and Republicans are not very happy (ahead of the Nov’24 election) about still elevated inflation compared to pre-COVID levels, still up by at least +20%, and insisting that Fed/Powell should focus on core CPI inflation rather than core PCE inflation, which is around 1.0-0.5% lower most of the times due to composition/weightage issue; ordinary people (vote bank) are worried about overall inflation (CPI), especially for daily essential goods & services, which is still significantly elevated than pre-COVID levels, while their real earnings may be still flat.

Powell also publicly acknowledged to a Senator in the last hearing/testimony (Mar’24) that US Congress officially mandated the Fed to maintain price stability mandate as +2% headline inflation (CPI), not PCE, which is always the lowest among various inflation gauzes. Powell pointed out that the Fed is now actually targeting core CPI inflation due to lower volatility (ex-food and fuel), which is still higher than headline CPI.

Overall, core PCE inflation is now a lagging inflation indicator, and does not impact the market meaningfully as the market already has an idea/estimate about the level after core CPI and PPI data, released almost 2-weeks ahead. Powell is under pressure by both Democrats and Republicans for various issues including still elevated inflation and also increasing unemployment. But at the same time, Powell may highlight the progress of disinflation and may indicate Fed may get the required confidence in rate cuts sooner rather than later.

 

Although the Fed generally targets +2.0% core PCE inflation as the price stability (inflation) target, in reality, it maintains that around +1.5%, which is equivalent to core CPI inflation targets around +2.0%. Before COVID, the Fed started cutting rates in late 2019 amid repo market disruptions (due to excessive QT) from Aug’19 (after Trump blasted out Powell), when 6MRA of core PCE inflation was around +1.6% and core CPI inflation was around +2.0%. Fed had cut rates from +2.50% to +1.75% in H2CY19 (pre-COVID).

Fed generally targets a 6M rolling average core PCE inflation rate of around +1.8% and +2.3% core CPI inflation on a sustainable basis; equivalent to +2.0% price stability core inflation targets. But 6MRA of core PCE inflation was around +2.8% and core CPI inflation was +3.2% in June’24; i.e. still around +1.0% higher than price stability targets. The normal run rate of disinflation is around -0.2% QTR to QTR sequentially, but it stalled in Q1CY24 after an unusual disinflation pace of -0.5% in the previous Q4CY23 QTR. Now the normal rate of disinflation -0.2% again happened in Q2CY24, but the Fed is still not confident enough to start the rate cuts cycle. That’s why Powell/Fed is now pointing out that although there is incrementally additional confidence in the last QTR (Q2CY24), It’s not enough still now. Although there was a rapid disinflation rate in H2CY23, the same was stalled in Q1CY24 and started again at a normal pace in Q2CY24; i.e. Fed will now observe actual data in Q3CY2 and the outlook thereof for any policy rate cut decision from Dec’24.

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 as the Fed may want to observe inflation and employment data for Q3CY24. Also, the Fed may be on the sideline till the Nov’24 US election amid growing political & policy uncertainty after Biden exited from the Presidential run, paving the way for the Trump-Harris fight, which may not be smooth for Trump.

Although the market is now almost discounting the start of Fed rate cuts from Sep’24, considering overall pace of disinflation, Fed may continue its wait & watch stance till at least Dec’24 and may continue to indicate on 31st July FOMC/policy meeting that Fed is gaining incrementally higher confidence for overall disinflation process till Q2CY24, but still it’s not enough for launching the rate cut cycle in Sep’24 as Fed may want to be more confident after having actual data for another QTR. If Q3CY24 average US Core inflation (CPI+PCE) indeed goes around +2.9%; i.e. below the +3.0% ‘confidence’ line, then the Fed may officially indicate the start of the 11-QTR rate cut cycle from Dec’24 QTR till Dec’27 (two half yearly rate cuts in 2027). The Fed will get the Sep’24 core inflation report by mid-late Oct’24 and accordingly may indicate the rate cut from Dec’24, just ahead of the Nov’24 election to keep both Democrats and Republicans happy; the Fed may indicate the start of a rate cut in Oct’24 (just ahead of the Nov’24 election) Fed talks and may start cutting rates from Dec’24 (just after the Nov’24 election).

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.

Market impact:

On Friday, Wall Street Futures, Gold surged despite hotter than expected core PCE inflation data as overall inflation data is still in line with market expectations, and the implied probability of a rate cut in Sep’24 still hovering around 90%. Also after some initial confusion, Trump was again running ahead slightly against Harris (46% vs 45%) and thus Wall Street surged Friday on Trump 2.0 (Trumponomics-rate cuts, deregulation, and infra stimulus) optimism.

Again Trumponomics means higher deficit, higher debt, and more devaluation of currency (USD)-which will eventually cause higher inflation and higher borrowing costs. All of these expect higher borrowing costs/higher bond yields are theoretically positive for Gold as a haven inflation hedge physical asset in limited supply (unlike infinite supply for paper/digital currency). Thus Trump 2.0 is also positive for Gold. Crypto-savvy Trump and his VP candidate are also positive for BTCUSD/Cryptos in general, although the ongoing Crypto bubble may eventually cause another US/Global financial crisis apart from the fact that Crypto is now merely a medium of financial exchange for illegal/terrorist/narcotics/criminal activities and the underlying tech is not fit for financial market.

On Friday, Gold also recovered amid lingering uncertainty of an imminent Gaza war ceasefire ahead of the US Presidential election due to domestic political compulsion. Both Democrats and Republicans are shying away from endorsing the Israeli stance on the Gaza war blindly as it would cause a loss of votes from not only the Muslim community but also non-Muslim immigrants and even Native Americans. On the other side, due to their domestic political compulsion, Israel, especially PM Netanyahu, is not ready for any reasonable/practical compromise, which may harm his political career.

On Friday, stimulus-addicted Wall Street surged on hopes & hypes of an imminent dual stimulus-Fed’s monetary stimulus (11 rate cuts) and Trump’s fiscal stimulus (rate cuts/extension, deregulation, and infra stimulus) in early 2025. Wall Street was boosted by all the major sectors led by industrials, materials, real estate, banks & financials, consumer discretionary, techs, utilities, communication services, consumer staples, healthcare and energy. Script-wise, Wall Street was boosted by 3M (upbeat report card/guidance), Salesforce, American Express, Visa, Travelers, United Health, Caterpillar, Home Depot, JPM, Intel and Apple, while dragged by Merck, Walmart and IBM. Blue Chip

On Friday, DJ-30 surged over +400 points, tech-heavy NQ-100 gained +0.6%, while the broader S&P 500 added +0.7%. For the week however, Wall Street was sharply down, with the S&P 500 slumping -1.9%, the Nasdaq-100 lost nearly -3.1%, and the Dow-30 slips almost -0.9% after subdued report card from Alphabet and Tesla and a broader rotation from techs into real economy stocks as Fed may soon launch rate cuts, while Trump 2.0 may also launch trade/tech tantrum with China again.

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

Whatever the narrative, technically Dow Future (40848) has to sustain over 41200 for any further rally to 41400/41500-41700*/41800 and 41950/42000*-42700 in the coming days; otherwise sustaining below 41100/40900-40700/40500, 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 (19173) has to sustain over 18800 for any recovery to 19300*/19600-19750/19950 and 20150*/20600-20800/21050 for a further rally to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 18700/18500-18200/18000 it may further fall to 17700 and 17600/17500-17300/17150 in the coming days.

Technically, SPX-500 (5498), now has to sustain over 5400 for any further recovery to 5475/5525-5605/5675 and rally further to 5725/5750*-5850/5800-6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5425/5400-5350/5300 may further fall to 5250/5200-5175/5100 and further 5000/4900*-4850/4825 and 4745/4670-4595/4400* in the coming days.

Also, technically Gold (XAU/USD: 2385) has to sustain over 2400/2410-2430/2440 for a further rally to 2455*/2490-2500*/2525 and 2550/2575-2600/2650 in the coming days; otherwise sustaining below 2395/2390-2385/2360-2350*/2340, may further fall to 2320/2300-2290/2275* and 2235/2210-2160/2110 in the coming days (depending upon Fed stance, Gaza/Ukraine war trajectory and US election outcome).