Dow jumped on hopes of a soft landing despite disinflation

·         Overall 6M rolling average of US Core CPI was 3.5% in July; the Fed may not launch eleven rates cut cycle until it goes below 3.0% by Dec’24

·         Hopes of an imminent Gaza war ceasefire also helped Wall Street, while dragging Gold and oil

·         On early Thursday, Wall Street Futures surged on Walmart boost, while Gold and oil also recovered as Hamas not attend Gaza war ceasefire talks at Doha

·         Robust US retail sales and soft jobless claims helped to ease the panic concern of a hard landing (all-out recession); Gold slips on fading hopes of an early Fed pivot

On Tuesday, Wall Street Futures recovered from an early loss and closed in deep green on the ease of Iran-Israel geo-political tensions and softer than expected US PPI data-boosting the implied probability of a Sep’24 rate cut by almost 95% from the prior 90%. Now all focus would be on July core CPI data to be released Wednesday. Although Powell said he (Fed) has now some confidence about the disinflation process, he (Fed) is not confident enough about going for rate cuts and thus he/Fed will be in wait-and-watch mode for the next few months. Powell also indicated Fed may be inching closer to the launch of eleven rate cut cycles. Fed/Chair Powell is now under huge pressure from financial journalists for rate cuts amid some signs of an economic slowdown and thus the market is now expecting -75 or even -150 bps rate cuts cumulatively in September, November, and December.

On Wednesday, all focus of the market was on U.S. inflation data for July as it may influence the Fed's decision for any rate action/policy stance change in September policy/dot-plots. On Wednesday, the BLS data (NSA) shows the annual (y/y) US core CPI inflation edged down to +3.2% in July’24 from +3.3% sequentially, in line with the market consensus of +3.2% and at the lowest over three years (since Apr’21).

On Wednesday, the BLS data (SA) showed the sequential (m/m) US core CPI increased +0.2% in July’24 from +0.1% in the preceding month, in line with the market expectations of +0.2%. In July, the sequential core CPI was boosted by shelter, motor vehicle insurance, household furnishings and operations, education, recreation, and personal care, while dragged by airline fares, used cars & trucks, medical care, and apparel.

 

Overall, the average of US core CPI was unchanged at +3.6% in 2024 (YTM) against +4.8% in 2023, and +6.2% in 2022, while the 6M rolling average was around +3.5% (y/y) in July, eased from the prior +3.6%. Still substantially above the Fed’s +2.0% targets and +3.0% levels, below which the Fed may feel confident enough to go for eleven rate cuts cycle.

The U.S. Core service inflation (w/o energy service) also eased to +4.9% in July’24 from +5.1% sequentially and Jan’23 reading of +7.2%, but it’s still substantially above pre-COVID average levels of 2.8%. The Fed is now closely focusing on core service inflation, which is still quite elevated and sticky led by Shelter/Housing inflation amid higher demand for housing an increasing number of immigrant workers (increasing population), and the legacy issue of lack of adequate supply of affordable housing in the US.

Unlike China, the US is unable to create affordable smart cities and high-speed railways for the increasing population due to a lack of political bipartisan consensus between Democrats and Republicans. The US is suffering long from political & policy paralysis to increase the supply capacity of the economy to serve increasing demand and balance inflation. Moreover, now homeowners are not ready to accept lower rent due to higher demand and higher borrowing costs (home/mortgage loans). In any way, in June’24, the US Shelter inflation also eased to +5.1% from +5.2% sequentially.

On Wednesday, the BLS data (NSA) showed the annual (y/y) US CPI inflation edged down to +2.9% in July’24 from +3.0% sequentially, below the median forecasts of +3.0%, and the lowest since Mar’21.

On Wednesday, the BLS data (SA) showed the sequential (m/m) US CPI surged at +0.2% in July’24 from -0.1% in the prior month, in line with market expectations of +0.2% advance. The index for shelter rose +0.4% in July; accounting for nearly 90% of the monthly increase. The energy index was unchanged over the month, after declining in the two preceding months. The index for food increased +0.2% in July, as it did in June. The food away from home index rose +0.2% over the month, and the food at home index increased +0.1%.

Overall, the 6M rolling average of US CPI was +3.2% in July’24 against +3.2% in the prior month and a yearly average of +4.1% in 2023 and still substantially above the Fed’s target of +2.0%; officially US Congress has given Fed price stability mandate as 2% CPI on a sustainable basis; not core CPI or core PCE and even total PCE inflation. However, the Fed usually takes the average of core PCE and core CPI inflation for any policy stance as core inflation generally gives a fair picture of underlying inflation; also there is a difference of around 50 bps between core CPI and core PCE inflation. But ordinary Americans are now concerned with higher cost of living expenses, which is total CPI, and thus ahead of the US election, both Democrats and Republicans are now grilling Powell for still elevated inflation, almost +20% high from pre-COVID levels.

The BLS data also shows US core core CPI (super core inflation w/o food, fuel/energy, shelter, and used cars & trucks) also ticked down to +2.4% in July’24 from +2.5% sequentially against pre-COVID average levels around +1.6%. On a sequential basis (m/m), the US Super core CPI increased + 0.205% in July against a contraction -0.154% in the prior month.

Fed may be looking around +1.5% US super core inflation, so that US core inflation (core CPI) may move below +2.0% targets on a sustainable basis. Looking at the trend/pattern of overall US core inflation (core CPI) data, the Fed may provide a rate cut signal in its next quarterly (Q3) September meeting (ahead of the Nov’24 election) as by then the 6M rolling average (6MRA) of core CPI may fall to around +3.3% from present (July’24) 6MRA +3.5%.

At present trend, the 6MRA of core CPI may further fall to around +3.0% by Dec’24, when the Fed may feel enough confidence to launch the 11 rate cuts cycle from Dec’24, just after the Nov’24 election, so that both Democrats and Republicans will be happy and Powell may be on the safe side from high probable Trump tantrum in future; if Trump indeed wins the Nov’24 election, he may try to undermine the role of Fed as an independent monetary authority (Central Bank), as we have seen during Trump 1.0.

From the 6MRA core PPI and core CPI data (R/R) sequential data, the sequential rate of core PCE inflation may be around 0.2-0.3% in July’24. Even if we assume a lower end +0.2% sequential rate of core PCE inflation in July’24, the annual (y/y) rate should come to around +2.7% in July’24 against +2.6% sequentially. In that scenario, the 6M rolling average of core PCE inflation should be around +2.7% against the 6M rolling average of core CPI around +3.5%, and the 6M rolling average of US core inflation (PCE+CPI) would be around +3.1%; the Fed may not start the rate cut cycle until this average core inflation (PCE+CPI) goes at least to +2.6% on a sustainable basis. This may not be possible before Dec’24. By Sep-Oct’24, this average core inflation should be around 2.9-2.8%, just below +3.0% on a consecutive basis, which should provide the Fed the much-awaited confidence to indicate the start of eleven rate cuts cycle (every QTR) from Dec’24.

Although the Fed generally targets +2.0% core PCE inflation as the price stability (inflation) target, in reality, it maintains that target around +1.5%, which is equivalent to core CPI inflation targets of 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).

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.

On Wednesday, Chicago Fed’s President Goolsbee said:

·         Rising unemployment may indicate a worsening job market

·         I am growing more concerned about employment

·         Because the Fed's rate decisions typically affect the economy only after an extended time lag, it must avoid waiting too long before reducing rates

·         There is a danger when central banks fall behind events on the ground. It's important that we not assume that if the labor market were to deteriorate past normal, we could react and fix that, once it's already broken

·         The law gives us two things that we’re supposed to be watching, and one of those things has come way down, and it looks very much like what we said we’re targeting (inflation), And the other is slowly getting worse, and we want it to stabilize

·         As inflation falls, inflation-adjusted real interest rates in effect rise. Higher rates mean that the Fed's policies are doing more to restrict borrowing and spending and to potentially cool the economy

·         Inflation, it’s clear, has been coming down for some time, and we’re quite restrictive

·         Fed’s key rate has increased even as inflation has fallen and is at the highest point in decades. And he pointed out that the job market is cooling

·         Fed officials, in their latest quarterly economic projections, predicted that they would cut their key rate at least five times by the end of 2025. Those forecasts assumed that the unemployment rate would be 4% at the end of this year, Goolsbee noted, yet the rate is now 4.3%; those estimates indicated multiple rate cuts would be appropriate through 2025 even with conditions that are less favorable than the ones we’re facing now

·         Core PCE inflation, according to the Fed's preferred measure, would be 2.8% by the end of this year. But it is already below that now, at 2.6%

·         In the long arc, it’s clear inflation’s coming way down. That’s what the path to 2% looks like. It’s clear what the trend is. We’re way, way down from where we were. And the job market is cooling, and it needs to settle at full employment

·         Goolsbee said current interest rates are very restrictive in an interview, a stance he said would only be appropriate if the economy were overheating but declined to comment on how likely or how large a rate cut might be at the Fed’s next meeting in September

·         When asked about the balance between inflation and labor-market risks, Goolsbee said, “It feels like, on the margin, I’m getting more concerned about the employment side of the mandate.”

·         While he noted the recent increase in the unemployment rate could reflect more people entering the labor force, it could also be an indicator that we’re not settling down at steady-state levels, but moving into something that’s, in the short-run, worse; If that starts to happen, then our emphasis has to be significantly more on the employment side of the mandate

·         If you were going into a recession or you believe that you were going into recession, that would affect the rate at which you’d be doing the cuts; Conditions are what will warrant the size of the cuts

Overall, on Wednesday Fed’s Goolsbee sounded quite dovish; arguing for the Sep’24 rate cut as present unemployment and core PCE inflation rate is already exceeding Dec’24 targets. But in the SEP/Dot-plots, the Fed usually projected core inflation and unemployment figures as an average of 12M or minimum of 6M, not a particular single month for the sake of sustainability issues. The YTM average unemployment rate was 3.9% in July, 6MRA at 4.0%, and 12MRA at 3.8%. Similarly, if July core PCE inflation indeed comes at +2.7% in July, the YTM, 6MRA, and 12MRA would be at 2.8%, 2.7% and 3.0%.

Conclusions:

Fed is not in a hurry to start the rate cut cycles of 11 QTR cuts without evaluating data for a few more months in totality. Thus Fed may not only evaluate inflation and employment data for July and August but also for September and October/ November before launching the much-awaited rate cut cycles from Dec’24 QTR end.

Despite the market now suddenly panicking for a hard landing for the ‘terrible’ NFP/BLS job report for July, if we consider the increasing number of multiple job holders, higher number of temporary layoffs, and an unusual addition in labor force due to one-time seasonal factor), the overall nature of US labor market is still strong enough for Fed to continue its wait & watch stance to gain more disinflation pace and required full confidence to launch the series of rate cuts from Dec’24 rather than Sep’24.

But even if the Fed responds to the present market panic and begins cutting rates from Sep’24 instead of Dec’24, it will make no significant difference in reality (Real Street) but may boost the sentiment of Wall Street by ensuring financial stability first. In that scenario, even if the Fed cuts the rate by -25 bps each (no question of -50 bps pace), it will continue the pace of 4 rate cuts each in 2025-26 and one QTR/HLY cut in 2027.

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 2.0.

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), keeping Wall Street near life time high with some healthy corrections.

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 wrap:

On Wednesday, Wall Street Futures closed mixed amid hopes & hypes of an early Fed rate cut from Sep’24 rather than Dec’24; the market is now expecting -100 or even -150 bps rate cuts in H2CY24 against Fed’s -25 bps rate cut projections (June’24 SEP/dot-plots). But the overall impact was limited as fine prints of July inflation (CPI and core CPI) show a muted disinflation pace and thus Fed may continue its wait-and-watch policy for the next few months to get more confidence for the launch of much-awaited rate cuts. The implied probability of a Sep’24 rate cut was almost unchanged.

On Wednesday, blue chip DJ-30 surged +0.61%, tech-heavy NQ-100 edged up +0.03%, while broader SPX-500 gained +0.38%. Wall Street was boosted by banks & financials, energy, techs, healthcare, consumer staples, industrials, and real estate, while dragged by communication services, consumer discretionary, and utilities. Crrip-wise, Wall Street was boosted by American Express, Home Depot, Travelers, Goldman Sachs, JPM, United Health, P&G, Walt Disney, Walmart, Nvidia and Broadcom while dragged Intel, Merck & Co, Caterpillar, Amgen, Boeing and Amazon to some extent. Alphabet tumbled on renewed regulatory concern of bifurcation of the big tech by US DOJ (to ensure fair competition)

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

Whatever the narrative, technically Dow Future (39300) has to sustain over 39900 for any further rally to 40100/40500-41050/41450 and 41675*/41950-42100*/42700 in the coming days; otherwise sustaining below 39800/39550, DJ-30 may again fall to 39200 and 39000/38800-38600/38300-38000 in the coming days.

Similarly, NQ-100 Future (18300) has to sustain over 18800-19000 for any further recovery to 19300/19600-19750/19950 and 20150*/20600-20800/21050* and further 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 (5300), now has to sustain over 5450 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: 2400) has to sustain over 2425-2440 for a further rally to 2455*/2490-2500*/2525 and 2550/2575-2600/2650 in the coming days; otherwise sustaining below 2420-2410, may fall to 2395/2385-2370/2360 and 2350*/2340-2320/2300-2290/2275* and 2235/2210-2160/2110 in the coming days (depending upon Fed stance, Gaza/Ukraine war trajectory and US election outcome).