Dow, Gold stumbled on mixed GDP and core PCE inflation data

·         The Dow was also dragged by China-savvy stocks after a terrible election debate by Biden against Trump; Fed may cut from Dec’24 instead of Sep’24

On Thursday some focus of the market was also on US GDP data. The BEA final 3rd estimate data shows U.S. real GDP for Q1CY24 was slightly revised up to around $22758.80B against $22679.30B sequentially (+0.4%) and $22112.30B yearly (+2.9%); all in 2017 constant prices and at seasonally adjusted annual rates. In other words, the U.S. economy has expanded by around +0.4% sequentially (Q/Q), which is equivalent to a +1.4% annualized rate, just above the prior 2nd estimate of $22749.80 (+1.3%), but lower than the 1st estimate $22768.90 (+1.6%). In the previous QTR, the U.S. Real GDP grew at an annualized rate of +3.4% to around $22669.90B.

The upward revision of US real GDP in Q1CY24 primarily reflected a downward revision to imports, which are a subtraction in the calculation of GDP, and upward revisions to non-residential fixed investment and government spending. These revisions were partly offset by a downward revision in consumer spending. Overall, the increase in sequential annualized real GDP in Q1CY24 primarily reflected increases in consumer spending; residential fixed investment, non-residential fixed investment, and state and local government spending that were partly offset by a decrease in private inventory investment and an increase in imports.

On an yearly basis (y/y), Q1CY24 real GDP grew +2.9% against +3.1% in Q4CY24 led by lower consumer & government (Federal/state/local) spending, and lower net trade (lower export/higher import), while boosted by higher residential fixed investment.

The US nominal GDP (at current prices) was also revised positively to around $28269.20 vs 2nd estimate of $28255.90B, but lower than 1st estimate of $28284.50 against $27957.00 sequentially (+1.1%) and $26813.60 yearly (+5.4%); i.e. the annualized growth rate for US nominal GDP was around +4.5% in Q1CY24.

Overall, the U.S. real GDP may grow around 2.4% in 2024, largely in line with the Fed’s estimate and trend rate. The U.S. real GDP got a boost of around $2T in 2023 after changing the base year from 2012 to 2017 constant prices. Consumer spending is the backbone of the US economy, contributing almost 69% of the real GDP, followed by private CAPEX/domestic investment (18%) and government spending (17%), while net trade (export-import) dragged -4%.

On seasonally not adjusted (NSA) and quarterly rate (not annualized), the actual US Real GDP was around $5573.10B in Q1CY24 vs $5761.50B sequentially (-3.3%) and $5415.40 annually (+2.9%). Although actual US real GDP (NSA/Not annualized), fell around -3.3% sequentially in Q1CY24, it grew around +2.9% annually (y/y). The actual nominal US GDP (NSA/NA) in Q1CY24 was around $6925.20 vs $7081.80 sequentially (-2.2%) and $6546.70 yearly (+1.1%).

The core price index for personal consumption expenditures (Core PCE) in the GDP data rose by an annualized +3.7% in Q1CY24, accelerating from the +2.0% increase in the previous QTR and below the 2nd  estimate of +3.6%. The US GDP price index (GDP deflator) was unchanged at +3.1% in Q1CY24 against +1.7% in the previous quarter.

Real GDP by Industry:

GDP by industry or value-added—a measure of an industry's contribution to GDP. Private goods-producing industries decreased 1.1 percent, private services-producing industries increased 1.9 percent, and government increased 2.3 percent. Overall, 15 of 22 industry groups contributed to the first-quarter increase in real GDP.

Within private goods-producing industries, the leading contributors to the decrease were durable goods manufacturing (led by primary metals) and nondurable goods manufacturing (led by petroleum and coal products). These decreases were partly offset by an increase in construction.

Within private services-producing industries, the leading contributors to the increase were retail trade (led by motor vehicle and parts dealers), finance and insurance (led by Federal Reserve banks, credit intermediation, and related activities), and health care and social assistance (led by ambulatory health care services). The increase in government reflected increases in state and local as well as federal government.

Overall on Thursday, Wall Street Futures and Gold briefly slipped on higher revision of Q1CY24 real GDP growths and core PCE index for consumption expenditure component in the GDP data, which may be indicating underlying robust consumer spending and hotter inflation. But overall, there was no meaningful reaction as as the Q1CY24 GDP report may not change the Fed’s plan for the rate action in the coming months as the overall trend is now showing Goldilock's nature (not too hot or too cold) from prior too hot.

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 (at 2017 constant prices; SA) for May was eased to +2.6% from +2.8% sequentially, in line with the market expectations of +2.6% and 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 at 2017 constant prices) the U.S. core PCE inflation eased to +0.1% in May from +0.3% in the last three months (Feb+Mar+Apr’24), in line with market expectations of +0.1% and slowest increase since Nov’23.

In May, 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 also unchanged at +0.1%.

Also, annual PCE service inflation eased to +3.9% in May’24 from +4.0% sequentially.

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

The Fed usually goes by a 6M rolling average of core PCE + core CPI inflation for any important policy move. As per the new series (2017 constant prices), the 6M rolling average core PCE inflation is now around +2.8% in May (vs +2.9% in the April report), while the 6M rolling average of U.S. core CPI inflation is now around +3.7% (vs +3.8% in April report); i.e. 6M rolling average of US core inflation (CPI+PCE) is now around +3.3% (vs +3.4% in April report), still far above Fed’s +2.0% targets, but not very much above +3.0% ‘confidence building’ levels.

We may see +2.9% average (6MRA) US core inflation by the Sep’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.

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 +4.5% (for 2023), which is now around +3.3% in 2024 (YTM-May). We may see a lower pace of disinflation in H2CY24 due to lower base effects and higher spending for the US election coupled with elevated crude oil prices, most probably around $90-95 due to increasing Gaza war geopolitical tensions (Israel-Hezbollah/Lebanon/Iran) and ‘Putin’s conspiracy’ (ahead of US election as Putin may be favoring Biden opponent Trump).

Fed needs an average sequential core PCE inflation rate of around +0.2% on a sustainable basis for its +2.0% core PCE inflation targets. But it’s still hovering around +0.3% for the last 6 months, while jumping +0.5% even in Jan’24. That’s why Powell/Fed is repeatedly pointing out Fed is not confident enough still now for the disinflation process. Although there was a rapid disinflation rate in H2CY23, the same was stalled in Q1CY24 and thus Fed will look at Q2CY24 data; i.e. overall H1CY24 data and outlook thereof for any policy rate cut decision in H2CY24.

 

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% 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 will again face the US Congress on the 9th and 10th of July in his semiannual testimony. He may be again grilled 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.

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. 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.

The 6M rolling average of US core inflation (PCE+CPI) was around +3.3% in May’24. Ideally, the Fed may start cutting rates from Sep’24 if the 6M rolling average of core inflation (PCE+CPI) indeed eases further below +3.0% by June’24 (H1CY24). The Fed wants to keep the real/neutral rate around +1.0% in the longer term (assuming a +3.0% terminal repo rate and +2.0% core CPI). At present real repo rate (adjusted 6MRA core CPI 3.70%) is around +1.80%, well above the restrictive minimum rate of +1.00%, which is creating some additional slack in the economy to compress elevated demand, so that it can match with presently constrained supply capacity of the economy and eventually inflation goes down to around +2.0% targets on a sustainable basis.

Looking ahead, core CPI may fall below +3.0% levels by Sep’24 from +3.4% in May’24, which may prompt the Fed to have the required ‘confidence’ that core CPI is falling towards +2.0% targets on a sustainable basis in the coming months and thus Fed may start cutting rates from Dec’24. Fed has projected in the June’24 dot-plots -25 bps rate cut in 2024, -100 bps rate cuts each in 2025 & 2026, and -50 bps in 2027 for a terminal neutral repo rate +2.75%.

Fed may not cut rates in Sep’24, just before the Nov’24 US election to avoid any political controversy. But the Fed may start the rate cut cycle from Dec’24 QTR (Q4CY24) and may cut cumulatively eight times in 2025-26 at each QTR end by -25 bps each; then Fed may cut twice in 2027 at June’27 (H1CY27) and Dec’27 (H2CY27) @-25 bps each. One month of data may not change the Fed’s narrative about higher for longer stance as the headline unemployment average is still below 4%, while average core CPI inflation is still above 3%; the Fed generally considers at least 6M rolling average of economic data to suit its narrative.

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.3% in May; the Fed may not start the rate cut cycle until this average of core inflation (PCE+CPI) goes at least below 2.9% on a sustainable basis. This may not be possible before Sep’24; i.e. Fed may not get the required confidence for indicating a definitive rate cut before Sep’24. In that scenario, the Fed may give a definitive signal for eleven rate cuts from Dec’24 QTR onwards in its Sep’24 dot-plots, just before the Nov’24 election to keep both Wall Street, Main Street as well as Capitol Hill Street happy; both Democrats and Republicans may not object Fed in that case; Powell will keep both sides of the political Street happy.

Ahead of the Nov’24 U.S. Presidential election, White House/Biden and also Fed/Powell are more concerned about elevated inflation rather than the healthy labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some anti-incumbency wave among the general public (voters) against Biden admin (Democrats) due to relatively higher cost of living. Thus Fed is now giving more priority to price stability than employment (which is still healthy- 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.

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 4.75-5.00% at any cost (against present levels of average core CPI around +4.0%); i.e. Fed will not allow core real bond yield above +1.00%. Fed has to also ensure Wall Street stability by keeping SPX-500 TTM PE around 25 rather than lower/mean levels around 20.

Also, the reduction of Fed B/S from around $8.97T to around $6.60T by Dec’25 (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). 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.; but in the process may have also caused huge inflationary pressure along with the deluge of COVID fiscal stimulus and direct fund transfer; all these may have caused the vicious cycle of higher deficits, higher debts, higher devaluation, higher borrowing costs, and still elevated inflation.

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 (around 22% of estimated US nominal GDP of around $30T by CY26). Fed may continue the QT (even at an officially slower pace) and rate cuts at the same time despite simultaneous rate cuts and QT being contradictory. Fed may say (like BOC) that as long as core inflation is above certain levels (say +3.00%), then the Fed may continue to maintain real policy rate in the restrictive zone (say 1.50-2.00% above average core inflation), even after the Fed may continue both rate cuts and QT to reduce overall restrictiveness in a limited way.

When core inflation moves closer towards +2.0% targets by Dec’25, then the Fed may close the QT, continuing for only rate cuts, which should ease financial conditions more, at least theoretically than the contra combination of rate cuts and QT at the same time. Overall, Fed rate cuts along with QT (even at a slow pace) may be less dovish than pure/only rate cuts (without QT) as QT is also equivalent to rate hikes to some extent.

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 despite the symbolic 25 bps rate cuts by ECB, BOC in June for domestic political/election compulsion. 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 indeed goes for 50-75 bps rate cuts in H2CY24, while the Fed is still on 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 political/election, inflation/economic narrative, and jawboning; they can’t afford to diverge too much against the Fed, all being equal.

Like in India, the US Presidential election in Nov’24 may be also acting as a big/moderate fiscal stimulus amid huge election spending, which may likely boost inflation again or prevent the disinflation process, making the Fed’s job harder to cut rates before Nov’24 election. Moreover, the Biden admin is spending huge for the US private defense industry in the name of aid to Ukraine and even Israel and will also actively participate in the reconstruction process of both Gaza and Ukraine when the war finally stops.

Although the US Treasury may have some control of certain FX assets and also the Gold reserves of Russia, Ukraine, and even Israel, the deluge of deficit/fiscal spending, debt, and money/currency (USD) printing is also boosting overall inflation. In H2CY24, the U.K., Canada, and various other developed economies in the EU are going for the general election, and economic issues such as elevated inflation/higher cost of living will be one of the major issues; most of the incumbent government is set to lose the election on higher inflation and also higher legal/illegal immigration issues, while higher immigration is also helping to cool labor market and wage inflation (higher supplies of workers/labor force).

For example, U.K. PM Sunak and his French counterpart Macron suddenly called for an early general/snap election in July after a recent softening in inflation data; although both are set to lose badly. But all this election spending will also act as some fiscal spending and will not help the present disinflation pace. And new governments may encourage more fiscal spending after years of fiscal austerity. Thus ECB, BOE, BOC, and even RBI should feel less confident about going for any new/further rate cuts until Fed cuts in Dec’24.

Thus almost all major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may not cut rates in H2CY24 if the Fed remains on hold; no central bank will go against the Fed irrespective of any narrative/rhetorics and make LCU weaker against USD, causing higher imported/total/core inflation in the process; all central banks led by Fed will continue the 24/7 jawboning to keep bond yields under control (indirect YCC like BOJ) and a vibrant financial/money/FX market!  Although the ECB and BOC have cut rates once (-0.25%) already –which may be due to domestic political compulsions (elections), looking ahead they may not cut rates further before Sep-Dec’24 as the Fed may not cut rates before Dec’24 and also may not provide a specific signal before Sep’24.

Market impact:

On Friday, Wall Street Futures, Gold stumbled despite softer core PCE inflation reading for May (+2.6% from +2.8%) as after the latest revisions, overall 6M rolling average is now around +2.8% against earlier +2.9%; i.e. the overall progress of disinflation is still incremental rather than monumental and Fed may go for -25 bps rate cuts from Dec’24 rather than Sep’24; the market is still expecting -50 bps rate cuts in H2CY24 against Fed’s dot-plots of only -25 bps one rate cut! Also, US/UM consumer confidence/sentiment data was revised sharply higher for June, and negative for risk assets. Although the US/UM 1Y inflation expectation was also revised lower, it’s now a lagging indicator (after lower core CPI data was published in mid-June).

On Friday, Wall Street was boosted by real estate, energy (higher oil), banks & financials, and industrials, while dragged by communication services, consumer discretionary, utilities, consumer staples, techs, healthcare, and materials. Script-wise, Wall Street was dragged by Alphabet, Meta, Netflix, Walt Disney, Nvidia, and Nike (subdued guidance). Apple, Visa, Microsoft, Boeing, and Amazon, while boosted by United Health, Caterpillar, Salesforce, JPM, Goldman Sachs, Chevron, IBM and Intel. For the month, broader SPX-500 surged +2.9%, blue-chip DJ-30 edged up +0.7%, while tech-heavy NQ-100 jumped +4.9%. For H1CY24, the SPX-500 added +15.1%, the Nasdaq +20%, and the Dow gained only +3.7%; AI chips optimism led by Nvidia and other AI Chip stocks boosted NQ-100.

On early Friday, Gold got some boost on lingering geopolitical tensions over the Gaza war (Israel-Hezbollah/Lebanon/Iran) as Israel may soon attack Hezbollah on the Lebanon border, which may cause wider regional conflicts involving Iran. On Saturday, Iran's UN Ambassador threatened ‘obliterating war’ if Israel launches Lebanon offensive, while the US warned full-blown conflict with Hezbollah could break out with ‘little notice’ and Israel’s Defence Minister Gallant said Israel not looking for war with Hezbollah; diplomatic route always better.

On Friday, Wall Street was also dragged by China-savvy US MNCs after the terrible election debate performance of Biden with Trump. Although Trump prefers for continuation of the 2017 tax cut policies beyond 2025, he may again adopt a nationalist trade war stance. Trump may again play the China tariffs card and thus China-savvy stocks such as Nike, Starbucks, Amazon, Apple, and Boeing were under stress. But after the terrible debate performance of ‘aging/sleeping Joe’ (Biden), Democrats may replace Biden with some other ‘young & dynamic’ person. But both Biden and Trump are in their 80s now; while Biden’s image is relatively clean (despite his son Hunter’s ‘laptop’ and alleged crony connection with China), Trump’s image is messed up after Jan’20 ‘Congressional coup’ (after election defeat to Biden). Trump is still alleging election manipulation by Biden.

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

Whatever the narrative, technically Dow Future (39400) has to sustain over 39500-39850 for any further rally to 40050*/40200-40350*/40500 and may further rally to 40600-40700/41000 and even 42000-42700 in the coming days; otherwise, sustaining below 39800/39600-39400/39200 may again fall to 39000/38800-38600/38400 and further 38200/38100-37900*/37600-37400 in the coming days.

Similarly, NQ-100 Future (20250) has to sustain over 20350-20500* for a further rally to 20700-21050 in the coming days; otherwise, sustaining below 20450-20300 may again fall to 20000/19850-19750/19650* and 19450/19100-18800/18500 and 18400/18100-18000/17700 and 17600/17500-17300/17150 in the coming days.

Technically, SPX-500 (5560), now has to sustain over 5650 for any further rally in the coming days; otherwise, sustaining below 5625/5600-5575/5550 may again fall to 5500/5450-6375/5350 and 5250/5200-5175/5100 and further 5000/4900*-4850/4825 and 4745/4670-4595/4400* in the coming days.

Also, technically Gold (XAU/USD: 2325) has to sustain over 2350-2365 for a further rally to 2375/2385-2395/2400 and further to 2410/2425-2435/2455* and 2475-2500; otherwise sustaining below 2345-2320, may further fall to 2290/2275* and may further fall to 2245/2230-2220/2180 and 2155/2115-2085/2045 in the coming days.