Wall Street recovered on softer GDP revision

Wall Street Futures and gold were already under stress, while USD/US bond yield surged since the Fed’s more hawkish than expected hold on 20th September and subsequent hawkish comments by various Fed policymakers, indicating a higher for longer stance. Fed is now insisting that one more +25 bps hike for a terminal repo rate +5.75% is not a big issue and will not cause an outright recession, but the Fed is now evaluating the duration of such terminal rate before going for any appropriate cuts in line with any meaningful fall in core inflation. This coupled with less hawkish talks by the ECB, BOE, and BOJ is boosting USD/US bond yields.

Overall, the Fed is not in a hurry to cut rates in H1CY24 and the market is now expecting two rate cuts of -25 bps each in September’24 and December’24, contrary to earlier perceptions of -50 bps rate cuts each in H1 and H2CY24, totaling -100 bps cuts in 2024. Fed has indicated only -50 bps rate cuts in 2024, stressing higher rates for a longer stance, which is affecting risk trade sentiment of Wall Street; boosting USD/US bond yields, dragging gold and stocks. Subdued discretionary consumer spending may affect corporate earnings significantly amid higher cost of living, higher cost of borrowing, and lingering macro-headwinds.

Apart from the concern of higher borrowing costs, Wall Street Futures were also affected by growing political and policy paralysis for the Biden admin, which is now running a minority government effectively after losing the House to Republicans in the Nov’22 mid-term election. Republicans are now planning another government shutdown and even an impeachment motion against President Biden. Moody's said: “A US government shutdown would underscore institutional and governance weakness, and would be credit negative for the US sovereign.” ‘Capitalist’ Wall Street is concerned about Biden’s ‘socialistic’ approach to striking UAW/auto workers; politics is getting priority over economics.

Wall Street was also affected by the renewed concern of a hard landing following terrible new home sales data and subdued consumer confidence. But hotter than expected U.S. durable goods order data for August dragged Wall Street and Gold as it would keep the Fed on a hawkish path going forward. On Wednesday, Dow Future further slid to a fresh multi-month low around 33544 but recovered from the Fed/Kashkari panic low amid renewed AI optimism. The U.S. President Biden stressed the promise of AI in a meeting with advisers.

On Thursday, the BEA final data showed the US economy grew at an annualized rate of +2.1% in Q2CY23, compared to the preliminary figure of +2.4%, 2nd  estimate of +2.1%, and the Q1 expansion of +2.0%. Consumer spending rose much less than initially expected (0.8% vs. 1.7% in the second estimate), but upward revisions were seen for nonresidential fixed investment (7.4% vs. 6.1%), exports (-9.3% vs -10.6%) and residential investment (-2.2% vs -3.6%). Government spending rose 3.3%, in line with the previous estimate. Meanwhile, the BEA made the annual revisions to remove fluctuations such as seasonal weather patterns and holidays. For the full 2022, economic growth was lowered by 0.2% to 1.9%, amid downward revisions to consumer spending, inventory investment, state and local government spending and exports as well as an upgrade to imports.

The Q2CY23 real GDP now is around $22225.40B in the final estimate against the Q1CY23 figure of $22112.30B (the seasonally adjusted annual rate at 2017 chained dollar constant prices).

Market wrap:

On Thursday, Wall Street surged on hopes of no government shutdown and a less hawkish Fed stance after Q2FY23 real GDP growth was finalized at +2.1% against market expectations of +2.2%, while overall CY22 real GDP growth was also revised lower at +1.9% against earlier +2.1% owing to various yearly seasonal adjustment. In Q2CY23, consumer spending was also revised lower, while the latest continuing jobless claims and pending home sales were softer than expected.

On Thursday, Wall Street was boosted by communication services, materials, consumer discretionary, real estate, techs, financials, healthcare, industrials, consumer staples, and energy, while dragged by utilities. Dow was boosted by Intel, Caterpillar, Cisco, UnitedHealth, JPM, Goldman Sachs, and Amgen, while dragged by Boeing, IBM, P&G, Walgreens Boots and Chevron.

Conclusion:

The Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a final pause in Dec’23.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%

Here:

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation (CPI+PCE) =5.50% (for 2022); H1CY23 average core inflation around +5.40% (~5.50%)

As there is no significant easing of core inflation, especially core service inflation, the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle. But, if core CPI inflation indeed eased further to below +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).

Looking ahead, oil prices may stay elevated in the coming months between $75-95 instead of the earlier $65-75 despite US efforts to bring more supply from, Mexico, Brazil, Iran, Iraq, and Venezuela. OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $90 will continue to boost energy/transportation/logistics costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $85 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.

The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face the daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.

Going by the present trend/run rate, the U.S. core CPI may fall to +3.8% by Dec’23 and +3.4% by Feb’24, which may keep the Fed to hold on rates at +5.7% till at least Aug’24 before going for any rate cuts -25 bps or even -50 bps each in Sep’24 and Dec’24. Fed would like to boost Wall Street as well as Main Street before Nov’24 U.S. Presidential election. Fed has to ensure a soft landing; i.e. price stability along with financial/Wall Street stability and Main Street stability.

Looking ahead, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, 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 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. 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 stability and soft-landing.

Overall, it seems that the White House would be quite happy if the Fed could bring back core inflation towards 2% on a durable basis, while keeping the unemployment rate below 4% ahead of Nov’24, the U.S. Presidential election. The Fed is itself eager to cut its losses by cutting rates. The U.S. 2Y bond yield is now hovering around +5.13% and may soon scale 5.25-5.50% in hopes of another +25 bps Fed rate hike for a terminal repo rate of +5.75%.

Bottom line:

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

Whatever may be the narrative, technically Dow Future (33825) now has to sustain above 33900 levels for any recovery to 34300/34555-34600/34825-35070/200-415/850 levels; otherwise, sustaining below 33850, may again fall to 33475/450 and further 33240/200 levels in the coming days.

Similarly, NQ-100 Future (14750) now has to sustain over 14600-550 levels for any recovery to 14925/15150-15325/15500 and 15750/900-16000/655 in the coming days; otherwise, sustaining below 14500 may further fall to 14300/175-100/13890 and 13650-13125 levels.

Gold (XAU/USD: 1876) now has to sustain above 1875 for any recovery to 1885/1900 and 1910/1920-1926/1937 and 1952/1970 levels; otherwise, sustaining below 1870-1865, may further fall to 1855/1820-1798/1700 level in the coming days.