Dow recovered on less hawkish Powell testimony; Gold surged

On Tuesday, Wall Street Futures were undercut by ‘lack of blockbuster’ budget plan/policy reform by China, an imminent end of Japan’s ‘powerful monetary policy’ (YCC/NIRP), and hotter than expected PMI reports, indicating possible higher inflation in the coming days coupled with Apple woes amid subdued Chinese sales. On Wednesday, the focus of the market was on Fed Chair Powell’s Congressional testimony.

Full text of Semiannual Monetary Policy Report to the Congress: Chair Jerome H. Powell

Chairman McHenry, Ranking Member Waters, and other members of the Committee, I appreciate the opportunity to present the Federal Reserve's semiannual Monetary Policy Report.

The Federal Reserve remains squarely focused on our dual mandate to promote maximum employment and stable prices for the American people. The economy has made considerable progress toward these objectives over the past year.

While inflation remains above the Federal Open Market Committee's (FOMC) objective of 2 percent, it has eased substantially, and the slowing in inflation has occurred without a significant increase in unemployment. As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals have been moving into better balance.

Even so, the Committee remains highly attentive to inflation risks and is acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials, like food, housing, and transportation. The FOMC is strongly committed to returning inflation to its 2 percent objective. Restoring price stability is essential to achieve a sustained period of strong labor market conditions that benefit all.

I will review the current economic situation before turning to monetary policy.

Current Economic Situation and Outlook

Economic activity expanded at a strong pace over the past year. For 2023 as a whole, gross domestic product increased by 3.1 percent, bolstered by solid consumer demand and improving supply conditions. Activity in the housing sector was subdued over the past year, largely reflecting high mortgage rates. High-interest rates also appear to have been weighing on business fixed investment.

The labor market remains relatively tight, but supply and demand conditions have continued to come into better balance. Since the middle of last year, payroll job gains have averaged 239,000 jobs per month, and the unemployment rate has remained near historical lows, at 3.7 percent. Strong job creation has been accompanied by an increase in the supply of workers, particularly among individuals aged 25 to 54, and a continued strong pace of immigration. Job vacancies have declined, and nominal wage growth has been easing. Although the jobs-to-workers gap has narrowed, labor demand still exceeds the supply of available workers. The strong labor market over the past two years has also helped narrow long-standing disparities in employment and earnings across demographic groups.1

Inflation has eased notably over the past year but remains above the FOMC's longer-run goal of 2 percent. Total personal consumption expenditures (PCE) prices rose 2.4 percent over the 12 months ending in January. Excluding the volatile food and energy categories, core PCE prices rose 2.8 percent, a notable slowing from 2022 that was widespread across both goods and services prices. Longer-term inflation expectations appear to have remained well anchored, as reflected by a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets.

Monetary Policy

After significantly tightening the stance of monetary policy since early 2022, the FOMC has maintained the target range for the federal funds rate at 5-1/4 to 5-1/2 percent since its meeting last July. We have also continued to shrink our balance sheet at a brisk pace and in a predictable manner. Our restrictive stance on monetary policy is putting downward pressure on economic activity and inflation.

We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. However the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2 percent.

At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment. In considering any adjustments to the target range for the policy rate, we will carefully assess the incoming data, the evolving outlook, and the balance of risks. The Committee does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.

We remain committed to bringing inflation back down to our 2 percent goal and to keeping longer-term inflation expectations well anchored. Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run.

To conclude, we understand that our actions affect communities, families, and businesses across the country. Everything we do is in service to our public mission. We at the Federal Reserve will do everything we can to achieve our maximum employment and price stability goals.

Highlights of Powell’s Congressional testimony/Q&A:

·         We do not expect it will be appropriate to reduce the policy rate until we have greater confidence in inflation moving sustainably toward 2%. It will likely be appropriate to begin dialing back policy restraint at some point this year

·         We are not looking for inflation to go all the way down to 2%, but we do need more evidence. As we go forward, 12-month inflation will continue to drop. I am not looking for better inflation readings than we've had, I am looking for more of what we have seen

·         If the economy evolves as we hope, interest rates will need to come down significantly over the coming years

·         CRE is a serious problem, and more serious in some banks and locations than in others; CRE risk is manageable

·         We are making sure banks with commercial real estate sector exposure can manage any losses, it will be a problem to work through for several years

·         We should be prepared to be surprised by the next chapter in the economy

·         It is likely sometime this year, if the economy evolves as we expect, that we will begin to reduce rates

·         The pace of public sector hiring is not something the Fed is concerned about

·         AI certainly can augment or replace labor, I'm not sure which one it will do

·         There is hope that current productivity gains will be sustained

·         We are on the path to bring inflation down as gently as we can

·         Artificial intelligence's impact on productivity is hard to say

·         Property insurance has been adding meaningfully to inflation

·         The Fed is focused and resolute on getting inflation down

·         We should be prepared to be surprised by the next chapter in the economy

·         It is likely sometime this year, if the economy evolves as we expect, that we will begin to reduce rates

·         Property insurance has been adding meaningfully to inflation

·         We should be prepared to be surprised by the next chapter in the economy.

·         The forecast housing services inflation will come down

·         The pandemic may have changed in a sustained way how we target inflation

·         There's no reason to think the economy is in or faces significant near-term risk of recession

·         Inflation has come down sharply

·         We are using our tools to keep a strong labor market and strong growth while making progress on inflation. We are on a good path so far in being able to get there

·         We are very focused on AI

·         CRE is a serious problem, and more serious in some banks and locations than in others

·         If the economy evolves as we hope, interest rates will need to come down significantly over the coming years

·         We are not looking for inflation to go all the way down to 2%, but we do need more evidence

·         As we go forward, 12-month inflation will continue to drop. I am not looking for better inflation readings than we've had, I am looking for more of what we have seen

·         Incoming data will determine when rate cuts begin

·         We would like to have more confidence in inflation, we have some confidence but want more

·         It is more important that we get this right than we do it fast; The strength of the economy and labor market means we can approach that carefully and thoughtfully

·         The strength of the economy and labor market means we can approach that carefully and thoughtfully

·         The forecast housing services inflation will come down

·         Fed is still discussing with concerned stakeholders/banks for the final shape of BASEL-III regulatory capital requirements; it will be implemented in a consensus way after some change hurry

·         We do not expect it will be appropriate to reduce the policy rate until we have greater confidence in inflation moving sustainably toward 2%

·         We will carefully assess incoming data, evolving outlook, and balance of risks

·         The economic outlook is uncertain, and ongoing progress to 2% inflation is not assured

·         The policy rate is likely at its peak for this cycle

·         It will likely be appropriate to begin dialing back policy restraint at some point this year

·         The economy has made considerable progress over the past year on the dual mandate

·         While inflation is still above 2%, it has eased substantially

·         Risks to achieving the dual goals are moving into better balance

·         Labor demand still exceeds supply, nominal wage growth has been easing

·         The Fed’s restrictive stance puts downward pressure on economic activity and inflation

·         The labor market remains relatively tight

·         Risks to both cutting rates too early and too fast as well as too late or too little

On Wednesday, Fed’s Daly said:

·         We are committed to finishing the job on price stability

·         Higher interest rates do raise housing costs temporarily, but they are needed to bring down inflation

·         Rising housing costs have been a key driver of higher inflation

·         The Fed is focused and resolute on getting inflation down

·         Policy is in a good place, but there is more work to do

·         I am encouraged we've been able to bring inflation down with the labor market solid

·         Holding on too long with rates could create an unforced error and hurt the economy

·         Fed is facing a calibration exercise on policy

·         I am encouraged we've been able to bring inflation down with the labor market solid

On late Wednesday, Fed’s Kashkari said:

·         The base case is no more rate hikes

·         If inflation flares again that could justify a rate hike

·         If inflation seems more entrenched than we think, the first thing the Fed would do is hold for longer

·         In December, I had expected two rate cuts in 2024

·         It's hard to see that I would now expect more rate cuts

·         If the economy continues to be healthy, why would we cut rates?

·         Base case no more hikes, but higher for longer if inflation entrenched

·         The US labor market is coming into better balance

On Wednesday, Fed’s latest Beige book said:

·         Economic activity increased slightly, on balance, since early January, with eight districts reporting slight to modest growth in activity, three others reporting no change, and one district noting a slight softening

·         Employment rose at a slight to modest pace in most districts

·         The outlook for future economic growth remained generally positive, with contacts noting expectations for stronger demand and less restrictive financial conditions over the next 6 to 12 months

·         Price pressures persisted during the reporting period, but several districts reported some degree of moderation in inflation

·         Consumer spending, particularly on retail goods, inched down in recent weeks

·         Overall, labor market tightness eased further

·         Wages grew further across districts, although several reports indicated a slower pace of increase

·         Loan demand was stable to down, and credit quality was generally healthy despite a few reports of rising delinquencies

·         Businesses found it harder to pass through higher costs to their customers, who became increasingly sensitive to price changes

·         Ongoing shipping disruptions in the Red Sea and Panama Canal did not generally have a notable impact on businesses during the reporting period

·         Economic activity increased slightly

·         Holding on too long with rates could create an unforced error and hurt the economy

·         I am encouraged we've been able to bring inflation down with the labor market solid

·         Holding on too long with rates could create an unforced error and hurt the economy

On early Thursday, Asian Session BOJ Board Member Nakagawa said:

·         Japan's economy progressing steadily toward meeting the price target

·         Gathering Information to Make Monetary Policy Decisions Amid Risks and Uncertainties

·         To decide whether to adjust YCC, risky asset buying, and other policies if sustained achievement of price goal is judged

·         Sees some weak signs in consumption data but no significant change to the trend of moderate increase

·         Capex moderately increasing as a trend

·         Sees Heightening Chance of Fairly High Wave Revision Compared to Last Year

·         Japan's economy is expected to keep recovering moderately

·         Inflation expectations to gradually increase towards price target

·         Japan's Economy to Achieve Positive Wage-Inflation Cycle

·         Consumer inflation must not sour and pull Japan back to deflation

·         Rising wages will likely support consumer sentiment, but there is a risk that real income could be lower than expected, impacting demand, the economy, and prices

·         Notes small and mid-sized firms negotiating higher prices for their goods

·         Expect a positive mechanism for the economy to strengthen gradually, leading to increased spending and expansion above potential rate

·         Steady progress is being made towards inflation target

·         Prospects of gradually achieving the 2% inflation target are heightening

·         Weak Consumption in Nominal and Real Terms, Warrants Attention

·         BOJ anticipates delays into autumn and beyond with small firms' wage negotiations

·         To scrutinize the duration of data analysis for policy decision

·         The fate of other unconventional monetary easing tools should be debated when considering ending negative rate

·         Consumption Developments Key in Deciding End of Negative Rates

·         Expect Wage Hikes and Sustainable Wage Gains to Support Consumption

·         No Need to Wait for All Small, Mid-Sized Firms' Wage Talks Outcome in Deciding When to End Negative Rates

·         Emphasizes the significance of maintaining an upward trend in wages and sustaining inflation at around 2%

·         No preset idea of ending YCC with the exit from negative rates

·         Ending negative rates not solely based on wage talks outcomes

·         To Review Data Ahead of Policy Meeting in 10 Days

·         Japan's finance minister says excessive FX volatility can hurt the economy

On early Thursday, Asian Session BOJ Governor Ueda said:

·         Possible to Exit Stimulus While Aiming for a 2% Inflation Target

·         To consider rolling back a massive stimulus program once the positive cycle of wages and inflation is confirmed

·         The likelihood of gradually achieving 2% inflation is rising

·         To assess and discuss policy tools at the upcoming meeting

·         Rate Hikes Dependent on Future Situation If Negative Rates Removed

·         Will assess, and discuss what to do with various tools at the policy meeting

·         Possible to exit stimulus measures while striving to achieve a 2% price target

On Wednesday, Fed Chair Powell sounded less hawkish as he signaled more rate cuts in 2025 than the 100 bps being shown in the official SEP/dot plots. As core inflation may stabilize around 2%, the Fed may cumulatively cut around 175-200 bps in 2025. Thus risk trade got some boost.

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). BOJ  may exit the so-called NIRP (on selected reverse repo account) and YCC policy in April.

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.

Market wrap:

On Wednesday, Wall Street Futures and Gold got some boost on less hawkish Powell's testimony as he indicated more rate cuts in 2025. Fed may also finish QT by June’24 before going for a rate cuts cycle from July’24. But on early Thursday European session, Wall Street Futures slipped to some extent as Fed’s Kashkari sounded less dovish. Also, BOJ’s ‘exit’ talks are hurting risk trade sentiment. Gold is surging on hopes & hopes of an early end of QT and more rate cuts in 2025 (under Trump's presidency).

On Wednesday, Sectorally Wall Street was boosted by utilities, techs, consumer staples, materials, healthcare, real estate, industrials, banks & financials, and energy, while dragged by consumer discretionary and communication services. Script-wise, Wall Street was boosted by Intel, IBM, Salesforce, Honeywell, Walmart, Merck & Co, JPM, CISCO, and Home Depot, while dragged by Walt Disney, Verizon, Chevron, Nike, Apple, J&J, Amazon, Goldman Sachs, 3M, Microsoft, United Health, Boeing and Amgen. Also, softer-than-expected ADP private payroll job addition and JOLTS job openings data boosted Wall Street Futures and Gold ahead of official NFP/BLS job data.

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

Whatever may be the narrative, technically Dow Future (38600), now has to sustain over 38300 levels for a further rally to 38600/39000 and 39700/39900-40200/40500 and even 42600  levels in the coming days; otherwise, sustaining below 39300 may again fall to 39250/200-39150/39000-38950/38600 and  38400/38200*-38000*/37300 levels in the coming days.

Similarly, NQ-100 Future (17960) now has to sustain over 18400 levels for a further rally towards 18500/18675-18975/19200 and 19450/19775-2000/20200 in the coming days; otherwise, sustaining below 18350/300-18250/200 may fall to and 17300-16830-16750-16550 in the coming days.

Also, technically Gold (XAU/USD: 2127) now has to sustain over 2165 for any further rally to 2175-2200; otherwise sustaining below 2165/2160-2150-2145, may again fall to 2100/2080-2060/2039, and 2020/2010-2000-1995/1985-1975 and even 1950 may be on the card.