Wall Street, Gold stumbled on fading hopes of March rate cut

Wall Street Futures (US stocks), Gold, and US bonds surged, while USD slumped after a more dovish than expected Fed hold Wednesday (13th December), in which the Fed indicated -75 bps rate cuts in 2024, most probably from June’24. Although the market was expecting around -100 bps rate cuts by Fed in 2024 before the Fed decision, it was boosted by -150 bps soon after Fed Chair Powell concluded his post-policy presser/Q&A, in which Powell didn’t attempt to present market pricing of an early rate cut in 2024 as ‘speculative & premature’ contrary to his last public comments 1st December, barely 12-days earlier, when Powell even batted for ‘higher for longer’ policy.

On Thursday, EURUSD surged on a hawkish hold by the ECB, especially hawkish comments by President Lagarde. As unanimously expected, the ECB held all key policy rates, but Lagarde categorically denied any official discussion about rate cuts (like the Fed), terming it as premature & speculative at this point. During the post-policy meeting presser/Q&A, ECB President Lagarde said policymakers/Governing Council (GC) did not discuss any rate cuts as it would be speculative & premature at this stage, reiterating that future decisions would be data-dependent (not Fed-dependent).

The market was pricing around -150 bps rate cut by ECB in 2024 (in line with Fed), but ailing & fragile-looking Lagarde, just recovering from COVID/acute bronchitis, basically trashed away the present market pricing of -150 bps rate cuts in 2024. Subsequently, EURUSD surged from around 1.09000 to 1.10000 on hopes of continuous policy divergence with the Fed.

Overall, like the Fed, the ECB also indicated they are at the peak of the terminal rate, which is now at a restrictive zone and has to maintain for sufficient time so that inflation will gradually fall to +2.0% targets. But unlike the Fed, the ECB denied any official discussion about any rate cuts at this point, terming it as premature.

Thus overall, it may be termed as a hawkish hold (higher for longer); the same stance is being taken by all other major G4 central banks like the Fed (until the 13th December Fed meeting), BOE, and BOC to ensure tighter financial conditions, higher borrowing costs and lower inflation expectations/lower demand/return to price stability without causing a hard landing. Subsequently, the USD/US bond yield slips, boosting Wall Street and Gold.

But late Thursday, the ECB blinked after seeing EURUSD approaching the 1.10 redline as a result of hawkish jawboning by Lagarde. ECB contradicted Lagarde by intentionally acknowledging preliminary discussions about rate cuts in the GC. ECB has to cut -75 bps in 2024 in line with the Fed to keep policy differential at present levels, everything being equal and irrespective of any inflation narratives. Subsequently, the USD/US bond yield recovered and Wall Street Futures and gold came under some stress.

On Thursday, Wall Street (US stocks) was also undercut by hotter-than-expected November retail sales and softer-than-expected jobless claims data as upbeat economic data/growth may prevent the Fed from an early rate cut stance. But US stocks eventually recovered to close at a fresh lifetime high as the Santa Rally was further boosted by the Fed pivot and hopes of an early end of the Gaza war amid intensified global pressure on Israel and the U.S.

On Friday, the ECB further indicated active GC discussion of rate cuts from Mar’24 and possible rate cuts from June’24 (in line with Fed-global synchronized easing for FX stability). ECB Policymakers said confidentially (floated trial balloons):

·         We don't expect to change the message on steady rates before the March meeting

·         Any cut before June would be difficult

On Friday, Wall Street Futures and gold stumbled, while USD surged after Fed’s Williams almost poured cold water on hops & hypes of an early Fed rate cut from March’24. The NY Fed President Williams is an influential FOMC policymaker and is seen as the ‘right-hand man’ of Chair Powell and a permanent member of the Chair’s inner team (permanent FOMC voter).

On Friday, Fed’s Williams said:

·         I am still highly uncertain about the economy, and inflation

·         Fed rate cut views depend on individual officials' views

·         I am not speculating on what will happen to rates

·         Fed is focused on whether rate policy is in the right place

·         We aren't talking about rate cuts right now

·         We are not ready to say when the balance sheet wind down (QT) stops

·         Reserves remain very abundant

·         The Fed needs to focus on objectives, not market views

·         The rate cut issue is not the main question before the Fed

·         It's premature to be thinking about a March rate cut

·         It's premature to even be thinking about the timing of rate cuts

·         The market reacting maybe more strongly than forecasts show

·         We will need to move policy back to more normal levels over time

·         Big market moves are a pattern for last year

·         Market reactions to all news has been quite large

·         The Fed must be ready to hike again if needed

·         We are at or near the right place for monetary policy

·         My base case for the economy is good, inflation is coming down

·         I am still highly uncertain about the economy, and inflation

·         If we get the progress I'm hoping to see, it will be natural to cut; of course, we need to move policy back to more normal levels over some time

·         Overall financial conditions have tightened

·         The question is: Have we gotten monetary policy to a sufficiently restrictive stance, that's what we're thinking about

·         It's looking like we're at or near 'sufficiently restrictive' but things can change

·         We need to be ready to tighten further if progress on inflation were to stall

·         The view of the committee is a gradual removal of policy easing over the next three years

·         The market reaction to all kinds of news has had a pattern of being larger than normal

·         The market reaction has gone further than our predictions

·         Right now we're seeing everything around QT and the balance sheet working as intended

·         Financial conditions have tightened in the big picture (despite a drop in 10y yields)

·         I just think it’s premature to be even thinking about that (rate cuts)---- It is looking like we are at or near that in terms of sufficiently restrictive, but things can change. One thing we’ve learned even over the past year is that the data can move and in surprising ways, we need to be ready to move to tighten the policy further if the progress of inflation were to stall or reverse

·         We’re very focused on the question in front of us, which as chair Powell said---is, have we gotten monetary policy to a sufficiently restrictive stance to ensure the inflation comes back down to 2%? That’s the question in front of us

·         We’re seeing a slowing in inflation. Monetary policy is working as intended. We just have to make sure that inflation is coming back to 2% on a sustained basis

On Friday, Fed’s Bostic said:

·         Cuts are not imminent but see two 1/4 point cuts in 2024

·         I won’t make too much of market actions since this week's policy meeting

·         The Fed has been surprised throughout the coronavirus pandemic, a reason for policymakers not to get anchored to a policy path

·         It will still take several months for the Fed to get an adequate signal and develop enough confidence in inflation’s continued decline to reduce rates

·         The risk of a new inflation spike has declined significantly

·         Business contacts are not talking as if large job losses are imminent, the Fed will listen closely for any change

·         Rate cuts are not an imminent thing, but have instructed staff to begin developing possible principles, and thresholds, to guide the process

·         I see two quarter-percentage-point interest rate cuts in 2024, with the first sometime in the third quarter, assuming expected progress on inflation continues

·         I see 2024 GDP growth at just over 1%, unemployment at 4% by the end of next year, and PCE inflation at 2.4%

·         Fed officials are pretty much in the same place right now that the policy rate is at a peak, conditional on inflation progress continuing

·         The US economy is still a ways from the Fed's 2% inflation target, though progress has been coming faster than I expected

·         Policymakers need to determine what the right neighborhood is for inflation that would warrant rate reductions, but data has been getting close

·         Inflation over 3- and 6-month horizons will be useful markers in coming discussion

·         The strength of the economy does still present the possibility of stalled progress on inflation, a reason not to overreact to recent positive signs

·         I won't make too much of market actions since this week's policy meeting

·         I am comfortable keeping rates higher for longer

·         It's Time to Be Resolute, Inflation Still Has a Ways to Go

·         Wage growth outpaces inflation; optimistic for improved sentiment

Overall, Fed’s Bostic sounded less dovish as he predicted (jawboned) -50 bps rate cuts in H2CY24, lower than the Fed’s dot-plots of -75 bps rate cuts, most probably in June-September and December’24 @-25 bps each (Q2/Q3/Q4).

On Friday, Fed’s Goolsbee said:

·         The unemployment rate tends to go up rapidly

·         I expect rates to be lower next year than now, but not significantly

·         Not ruling out the possibility of the Fed cutting interest rates at its meeting in March

·         The Fed may need to shift its focus to jobs

·         It’s important to be aware that historically when the unemployment rate starts going up; it doesn't just gradually drift up. It tends to go up rapidly

·         With inflation falling to the 2% target, it could be appropriate to be more mindful of the risk that unemployment rises

Overall, the Chicago Fed President Goolsbee sounded more dovish than his colleagues Bostic and Williams Friday as he is open for a March rate cut.

Conclusions:

If the US core CPI index grew by around +0.2% in Dec’23, the annual rate of core CPI would again come around +4.0%, translating to around +4.8% average core CPI for 2023. If US core CPI indeed dips below +3.0% by May-June’24 and if it seems that the 2024 average core inflation will be around +3.25%, then the Fed may start cutting rates from July’24 and may cut cumulatively 75-100 bps at -0.25% pace till Dec’24 for a repo rate at 4.75-4.50%, so that real rate continues to stand around +1.50%, in line with present restrictive stance (5.50% repo rate-4.00% average core CPI for last 6M).

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut (dovish jawboning) from Mar’24 (Q1CY24) to ensure a soft landing while bringing down inflation. Also, whatever the narrative, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 10% of its revenue as interest on public debt against China/EU’s 5.5%.

As a result of higher bond yields around 4.50%-5.00% (for 10Y UST); i.e. lower bond prices, the Fed is now in deep MTM loss for its huge bond holding. Fed is also providing higher interest to banks & financials for reverse repo operation than it getting under repo operation; i.e. Fed’s NIM/NII is now negative and theoretically Fed is insolvent to the tune of -$30B. The same is also true for various banks & financials, most of which are now in deep MTM loss for higher bond yields; i.e. lower prices for their HTM bond portfolio holdings due to Fed hikes. The US10Y TSY market price falls from around $140 to $105 from Jan’20 (pre-COVID) to mid-Oct’23; i.e. a fall of almost -33% in around 4 years.

This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price & financial stability and soft-landing. Fed has to bring down inflation to +2.0% targets by ensuring US 10Y bond yield below 5.00-5.25%, and an unemployment rate below 4.0% without triggering an all-out or even a brief recession in the US Presidential election year (Nov’24). The Fed will ensure that the US10Y bond yield is below 5.00-5.25% at any cost for lower borrowing costs for Uncle Sam (U.S.), everything being equal. Thus, overall Fed is methodically jawboning on both sides (hawkish/dovish) from time to time to achieve all its goals at the same time.

Considering all pros & cons, Fed may wait for core inflation data (average for core PCE and core CPI) for at least Dec’23-Mar’24 and if it goes down to around +4.00% from the projected 2023 average of +4.5% (4.80% core CPI and +4.20% core PCE), the Fed may cut rep rates/FFR by -25 bps in June; further if such disinflation trend continues, Fed may cut -25 bps each in September and December for a cumulative -75 bps. And if average core inflation slid more than expected, then the Fed may cut from March-May’23 for -100 bps cumulatively.

We may see a synchronized global easing from June’24 @-25 bps each in Q2-Q3-Q4 for a cumulative -75 bps in 2024. As the Fed is the world’s unofficial central bank because the USD is the ‘King’ (the world’s most preferred FX or global reserve currency), all major G20 central banks are now bound to follow the Fed policy stance to maintain present policy/currency/bond yield parity, everything being equal. Thus the market is now expecting a synchronized global easing (rate cuts) by major G20 global central banks including ECB, BOE, BOC, PBOC, and even India’s RBI, whatever may be the domestic macro-economic narrative (just like post-COVID synchronized global tightening to bring inflation down to targets).

Fed policymakers will now jawbone the market in a balancing way to keep the US10Y bond yield between 3.25-5.25% range or around +4.00% on an average to maintain price/labor market/financial (Wall Street) and also Main Street/White House stability in the election year (2024). As the U.S. labor market is still robust with healthy wage growths, the incumbent Biden admin may prefer price stability and lower inflation in the coming months along with a sub/below 4% unemployment rate. As the 10Y bond is the main instrument for raising debt and a benchmark for US/global borrowing costs, the Fed may not allow it to hover above 5.00% for long under any circumstances, everything being equal.

Market wrap:

On Friday, Wall Street Futures and gold slipped, while USD/US bond yield recovered as Fed’s Williams and Bostic almost poured cold water on the market perception of the March’24 cut. But the overall impact was limited as Fed’s Goolsbee also sounded more dovish than Bostic and Williams. Thus Wall Street closed mixed/almost flat Friday, marking a 7-week winning streak/Santa Rally despite a triple witching expiration event. Also, hotter than expected US Service PMI data (S&P Global) undercut, while softer than expected NY Empire State manufacturing index buoyed Wall Street.

On Friday, Wall Street was boosted by techs, consumer discretionary, and communication services/social media/telecom companies, while dragged by utilities, real estate, healthcare, energy, banks & financials, industrials, and materials. The blue-chip Dow Jones (DJ-30) was boosted by Boeing, Intel, Salesforce, Microsoft, American Express and Cisco, while dragged by Verizon, J&J, McDonald’s Goldman Sachs and Coca-Cola.

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

Whatever may be the narrative, technically Dow Future (37667), now has to sustain over 38000 levels for a further rally in the coming days; otherwise, sustaining below 37950-37850 may fall to 37000-36850-36650 levels may again fall to 36400/36200-36050/36000-35800/35500 and may further fall to 35350/35250-35000/34800 and 34650/34120-34000 and 33700/33200-33000/32400 in the coming days.

Similarly, NQ-100 Future (16818) now has to sustain over 17000 for a further rally; otherwise sustaining below 16950/16900-16850/700, may fall to 16500/16250, and further 16100/16050-15700/15400, and further 15100-14140 in the coming days.

Also, technically Gold (XAU/USD: 2019) now has to sustain over 2055 for a further rally to 2065/2075-2130/2152 levels; otherwise sustaining below 2050/2040, may fall to 2020/2000-1975-1960/1950 and 1928/1908 in the coming days.