Wall Street, Gold wobbled on soft ADP and hot ISM Service PMI

·         But the Fed may not cut rates in Sep’24, just ahead of the Nov’24 US election and lack of required confidence about the pace of US disinflation

On Monday, Wall Street Futures were mixed as blue-chip DJ-30 wobbled amid reports of Gaza war ceasefire progress after initial obstacle and mixed US Manufacturing PMI report by ISM and S&P Global, while tech-heavy NQ-100 surged +0.5%, led by NVIDIA/AI chip boost. On Tuesday, Wall Street Futures were almost flat, while DJ-30 surged on Boeing boost. Wall Street and Gold were also boosted by softer-than-expected JOLTS job openings data, while undercut by hotter-than-expected US factory orders; techs also helped to some extent as usual.

On Wednesday, some focus of the market was also on ADP private payroll job data ahead of official NFP job data on Friday. On Wednesday, the ADP flash data shows Private nonfarm payrolls in the U.S. (only private establishment/business employees) added +152K payroll jobs in May from +188K sequentially (m/m) and +206K yearly (y/y), lower than the market expectations of +152K, and also lower than the +165K NFP/BLS Private Payroll expectations by the market (to be released on Friday). Wage growth was unchanged for the 2nd consecutive month at +5%.

As per ADP, in May, the U.S. private services sector added +149K jobs in the service-providing sector added 149K jobs, mostly trade, transportation & utilities (+26K); education/health services (+46K); financial activities (+28K); and leisure/hospitality (+12K), while job losses occurred in information (-7K) and professional/business services (-6K). The goods-producing sector added +3K jobs, led by construction (+32K), while both manufacturing (-20K) and natural resources/mining (-9K) shed jobs.

The ADP said:

·         Job gains were slower in May due to a steep decline in manufacturing

·         Leisure and hospitality also showed weaker hiring

·         Job gains and pay growth are slowing going into the second half of the year

·         The labor market is solid, but we're monitoring notable pockets of weakness tied to both producers and consumers

 

As per the ADP survey, the nominal number of U.S. private employees was around 132072K in May against 131920K sequentially. The 2024 YTM average of private job additions as per the ADP survey is now around +167K against the 2023 average of +209K, while the 6M rolling average is now around +167K. The 2024 YTM (till April) average for private payroll job addition as per the NFP/BLS job report was around +197K against the 2023 average of +192K.

Overall, the ADP Private payroll job report was softer than expected, and subsequently, Gold and Wall Street Futures were boosted to some extent on hopes of an early Fed pivot/rate cuts from Sep’24 rather than Dec’24 or even from Mar’25. But most of the time, there are significant divergences between ADP and NFP private payroll data. Thus the overall boost was quite limited.

On Wednesday, the market focus was also on ISM and S&P Global service PMI data to have an early assessment of the health of service industry heavy US economy:

The ISM data shows services PMI in the US surged to 53.8 in May from 49.4 sequentially, above market expectations of 50.8 and the highest expansion in the last nine months. The Apr’24 reading of 49.4 was the 1st contraction of the US private service sector since Dec’22.

ISM said:

“In May, higher business activity, faster new orders growth, and slower supplier deliveries drove the growth despite the continued deterioration in employment. Business activity/production and new orders grew faster and new export orders rebounded. At the same time, price pressures eased and supplier deliveries slowed. Also, employment continued to contract and inventories rose less.

Employment challenges remain due to difficulties in backfilling positions and controlling labor expenses. The majority of respondents indicate that inflation and the current interest rates impede improving business conditions. The ISM Business Survey Committee members continued to express the criticality of interest-rate clarity on their jobs. But markets seemed happy to simply take the “W” on the news, continuing at or near record highs and proceeding like a loosening of Fed policy is no longer an if, even if the when is uncertain. Everyone got excited last month with the contraction, and we said to hold on and wait and see how this trends over three or four months. What we are again seeing is the resiliency of the services sector”.

On Wednesday, final data shows S&P Global Service PMI for the U.S. was confirmed at 54.8 in May, not changed from the flash estimate, and the strongest growth in the US private services sector in a year. The increase in business activity reflected a renewed expansion of new orders, which rose modestly following the first reduction in six months during April, prompted by marketing activity and improvements in economic conditions. New export orders, however, creased for the fourth month, as price rises had impacted external demand.

Also, employment was reduced for a second month, often reflecting the non-replacement of leavers. Still, higher staff costs were again the key factor behind a sharp rise in overall input prices as wages were increased. The pace of input cost inflation quickened and firms raised their charges at a solid pace. Signs of demand improving were a factor behind a slight strengthening of business confidence, which nonetheless remained softer than the series average.

Finally, the S&P Global data shows US composite PMI rose to 54.5 in May, surging from 51.3 sequentially, against a flash estimate of 54.4 and the sharpest increase since Apr’22 as growth accelerated in both manufacturing (PMI at 51.3 vs 50.3 in April) and services (PMI at 54.8 vs 51.3). Producers output due to a renewed rise in new orders, following a slight decline in April, and new export business saw a marginal increase. Employment levels remained steady overall, with increased manufacturing jobs offset by lower staffing in services. Input costs and selling price inflation both accelerated. Business confidence improved slightly, with companies optimistic about future output growth.

Conclusions: Fed may continue to be in ‘wait & watch’ mode; may not cut even in Sep/Dec’24 and may also revise June dot-plots

The 6M rolling average of US core inflation (PCE+CPI) was around +3.4% in Apr’24. Ideally, the Fed may start cutting rates from Sep’24 if the 6M rolling average of core inflation (PCE+CPI) indeed eases further to +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 inflation).

But in the meantime, till the Fed is confident enough that core inflation is going down to around 2.00% on a sustainable basis, the Fed may maintain the real rate at around present restrictive levels of 2.00% (assuming the present repo rate of 5.50% and 6M rolling average core inflation around 3.50%). Fed needs a +2.00% restrictive real rate for some time to produce sufficient slack in the economy, so that core inflation falls to +2.0% target on a sustainable basis.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C-D)*(E-B)

=1.50+2.00+ (2.60-2.00)*(4.50.00-2.00) =1.00+2+ (0.60*2.50) = 3.00+1.50=4.50% (By Dec’24)

Here:

A=desired real interest rate=1.50; B= inflation target =2.00; C= Actual real GDP growth rate for CY23=2.6; D= Real GDP growth rate target/potential=2.00; E= average core (CPI+PCE) inflation for CY23=4.50%

But the Fed may blink on rate cuts in H2CY24 just before the US election to avoid any political controversy:

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.

Fed may have cut from Septenber’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 Street and also Main Street (investors/traders/voters). But the Fed/White House may not take such rate cut risk as the Fed has to prepare the market fully at least 2-3 months in advance for such rate cuts and bond yield/overall financial condition will get easier/loser and may boost inflation again just ahead of Nov’24 election. Fed hiked rate last on 26th July’23 and hold since Aug’23 and may continue to be on hold till at least July’24, or even Dec’24 i.e. around 12-18 months for more/full transmission of its +5.25% cumulative rate hikes effect into the real economy.

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 4.76-5.00% at any cost (against present levels of average core CPI around +4.0%). Fed has to also ensure Wall Street stability by keeping SPX-500 TTM PE around 25 rather than lower/mean levels around 20.

Ahead of the Nov’24 US Presidential election, as seen in the Mar’24 Congressional testimony, Fed/Powell is under huge pressure from opposition Republican lawmakers to support Biden & Co (Democrats) in boosting the election prospect by facilitating rate cuts just before the Nov’24 election. Thus Fed may not go for any rate cuts till Nov’24 or even Dec’24 to show that it’s politically independent/neutral.

Average US inflation is now higher by over 20% from pre-COVID (Jan’20) levels, while under normal conditions, it should be around +8%; higher cost of living is creating some anti-incumbent wave against Biden admin before Nov’24 election; thus both White House and Fed are now prioritizing to keep inflation under control and not ready to risk of higher inflation by cutting rates just ahead of the election

Ideally,  in normal times (without any general election), the Fed should have cuts of -75 bps cumulatively in September, November, and December’24 for +4.75% repo rates from the present +5.50%. But after recent remarks by various Fed policymakers, it seems that the Fed may not cut thrice in 2024 from Sep’24 and may cut only once (symbolic) in Dec’24 or may not cut at all in 2024.

The market is now expecting 3 to 1 rate cuts in 2024, while some Fed policymakers are now arguing for lesser rate cuts of 1-2 rate cuts or even no rate cuts at all. Looking ahead, the Fed may not cut rates at all in 2024 considering the slower rate of disinflation, and political issues ahead of the Nov’24 election. 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.

Fed’s mandate is now 2% price stability (core inflation), below 4% unemployment rate, and below 4.75-5.00% US 10Y bond yield to ensure lower borrowing costs for the government and overall financial stability. Fed, as well as ECB, BOE, and BOC, are now struggling to keep bond yields at their preferred range despite non-stop jawboning; perhaps they are talking too much too early and thus FX market is not being influenced by them significantly, the the moving in a narrow range.

At present, in its last (Mar’24) SEP/dot-plots, the Fed projected -75 bps rate cuts each in 2024, 2025, and 2026 and -50 bps rate cuts in 2027 for a terminal neutral repo rate +2.75% against pre-COVID neutral repo rate +2.50%.

Looking ahead, in its June dot plots, the Fed May revise rate cut projections. Now various Fed policymakers are arguing for a slightly higher terminal repo rate at +3.00% against projected core CPI of +2.00%; i.e. neutral real rate at +1.00%. Thus depending upon the actual trajectory of core CPI, the Fed may cut -100 bps each in 2025, 2026, and -50 bps in 2027 for a terminal neutral repo rate of +3.00% from the present +5.50%.

Another scenario: Fed may also cut -50 bps in Dec’24 and -25 bps in Jan’25 after the Nov’24 US election to compensate for H2CY24 rate cuts (for election), if average core inflation indeed goes below 3% by Dec’24 and to avoid any hard landing feeling, if Wall Street plunge (for keeping rates too high for too long).

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 being contradictory. Fed may say (like BOC) that as long as the policy rate is in the restrictive zone (say 1.50-2.00% above average core inflation), the Fed may continue both rate cuts and QT to reduce overall restrictiveness. When the policy rate moves into a neutral/stimulative zone, say 50 bps above average core inflation, then the Fed may go for more rate cuts and close the QT. Overall, Fed rate cuts along with QT (even at a slow pace) may be less dovish than pure/only rate cuts 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. 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 inflation/economic narrative/jawboning; they can’t afford to diverge too much against the Fed.

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 even in Dec’24. 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 printing is also boosting overall inflation. In 2024, the U.K., Canada and also various other developed economies are going for general election, and economic issues such as elevated inflation/higher cost of living will be one of the major issues. For example, U.K. PM Sunak suddenly called for an early general election in July after a recent softening in inflation data. But all this election spending will also act as some fiscal spending and will not help the present disinflation pace. Thus Fed as well as ECB, BOE, BOC and even RBI should feel less confident about going for any rate cuts in H2CY24.

Thus almost all major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may not cut rates in 2024 if 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, ensuring robust employment globally!

Market impact:

On Wednesday, Wall Street Futures, Gold was buoyed by softer than expected ADP Private payroll job data, while undercut by hotter than expected ISM Service PMI data; but eventually Wall Street Futures also surged on the fading concern of a hard landing after upbeat Service/Composite PMI data following a subdued ISM Manufacturing data a few days ago. On Wednesday, Wall Street Futures were also boosted on hopes of an early Fed rate cut from Sep’24 after neighbor BOC cut the rate by -0.25% (as expected by the market); but a BOC rate cut of -25 bps may be & done until Fed goes for rate cuts in the coming months. as BOC may now like to maintain around -50 bps rate differential with Fed to keep CAD (LCU) at an attractive levels for export edge.

On Wednesday, blue chip DJ-30 surged around +96 points, broader SPX-500 jumped almost +1.2%, while tech-savvy NQ-100 soared +2.00% and both closed at record highs. Wall Street was boosted by techs, communication services, industrials, materials, consumer discretionary, healthcare, and banks & financials, while dragged by utilities, consumer staples, real estate, and energy to some extent. Script-wise, Wall Street was boosted by Intel, NVIDIA (AI chips optimism), Microsoft, Apple, Amazon, IBM, Goldman Sachs, Visa, Boeing, and Caterpillar, while dragged by Cisco, Walt Disney, J&J, American Express, McDonald’s, JPM, Nike and United Health.

On early Thursday, Wall Street Futures and Gold stumbled on fading hopes of an early Fed pivot, but EU/German stock Futures also surged on hopes of an ECB rate cut in June; USD/US bonds surged.

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

Whatever may be the narrative, technically Dow Future (38821) has to sustain over 39100 for any recovery to 39200//39300-39400*/39700 and 39800/40200-40350*/40500 and may further rally to 40600-40700/41000 and even 42000-42700 in the coming days; otherwise, sustaining below 39000-38900 may further fall to 38750/38550-38450/38250 and 38100/37900*-37600/37400 in the coming days.

Similarly, NQ-100 Future (18592) has to sustain over 18700 for a further recovery to 18800/189000-19000/ 19100 and a further rally to 19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 18600 may again fall to 18400/18100-18000/17700 and 17600/17500-17300/17150 in the coming days.

Also, technically Gold (XAU/USD: 2340) has to sustain over 2330 for any recovery to 2355/2365*-2375/2385 and further rally to 2400/2425-2435/2455* and 2475-2500; otherwise sustaining below 2325, may further fall to 2315/2300-2290/2275* and further to 2245/2230-2220/2180 and 2155/2115-2085/2045 in the coming days.