·         Techs dragged as Trump 2.0 may cause more tech war along with tariff; potential Trump and Fed policy uncertainty negative for stocks

·         Fed talks last week indicated Fed may not be in a hurry to cut rates in 2025

·         Fed may close the QT by June’25 first and then resume cutting rates as QT and rate cuts are two contra tools; QT boosting bond yields despite rate cut optimism

Wall Street Futures were almost flat Thursday but got some boost in the last few days amid tech and holiday season consumer spending optimism. On Thursday, Gold was also buoyed by fading hopes of an imminent Gaza war ceasefire as Israel negotiators returned home from Qatar/Doha to consult PMO, while Mossad Chief reportedly advised PM Netanyahu to attack Iran directly to eliminate Houthis and other proxy enemies. But Israeli PM Netanyahu didn’t agree.

Fast forward to, the early Asian session Friday, Gold was undercut on renewed hopes of a Gaza war ceasefire as Netanyahu reportedly asked for the hostage/prisoner list to make a deal. Netanyahu said late Thursday that it would not be possible to reach a hostage and ceasefire deal without getting a list of hostages held by Hamas: "We are not able to get names from Hamas and I am not willing to make a deal without knowing what I am agreeing to and who I am getting back--after the later round of negotiations in Qatar, it is unclear who makes decisions in Hamas after its leadership was eliminated.”

The military conflict between Israel and Houthis escalated:

On Wednesday, IDF hit Yemen targets including Sanaa airport. The Israel Defense Forces (IDF) carried out airstrikes targeting ports and energy facilities in the Yemeni capital Sana. In addition, an Israeli general said his country will step up attacks against the militant group in retaliation for their attacks on Israel. This follows a series of ballistic missile and drone attacks launched on Israel from Yemen by Houthis, forcing millions of Israelis again to shelters; 18 persons were lightly hurt rushing to safe space.

Meanwhile, Netanyahu also doubled down on Iran's proxy Houthis and warned:

·         Houthis will learn what Hamas, Hezbollah, the Assad regime, and others have learned

·         We are determined to cut off this terrorist arm of Iran's evil axis

·         We will persist in this until we complete the task

·         IDF struck Yemen's coastline and Sanaa, targeting the Houthi terrorist organization

·         We are determined to cut off this terrorist arm of Iran's evil axis. We will persist in this until we complete the task.

Now from the Gaza to Ukraine war, late Thursday, the Russian President also said though, Russia wants an imminent ceasefire, it will also not hesitate to change its nuclear doctrine, considering the recent spate of US/NATO rhetorics.

Overall, Gold is waving for escalation and de-escalation of Gaza and Ukraine war geopolitical tensions.

Now from lingering geopolitics to economics, last Friday (20th Dec 24), Fed’s Daly said:

·         Risks to the outlook are equally balanced

·         I think we have a policy in a good place, prepared for what is before us

·         We don't know what the incoming administration will do so for me it's about the data

·         The inflation rising was part of the reason you saw rate cuts dialed back in the SEP

·         The recalibration phase is now over

·         I'm not comfortable with inflation at 2.5% but we're balancing that with the labor market.

·         Firms are saying they can find workers, and workers saying they can find jobs, we don't want that to break.

·         I hear from contacts the economy is in a good place and the labor market is solid.

·         The level of uncertainty now is normal, not like the period around the pandemic.

·         Incoming data shows consumer spending and growth are much stronger; disagreement about the neutral rate.

·         Now you should expect more disagreement and differences of opinion

·         We have a healthy level of discussion and disagreement in the FOMC

·         We're working toward that soft landing

·         I see policy in a position supporting both goals, lowering inflation but not breaking the labor market.

·         My projection is it will take many fewer rate cuts next year than we had thought.

·         I was comfortable with the median outlook

·         Now you wait watchfully before making further cuts

·         We can return to a more typical pattern of gradualism

·         Ultimately I determined that 100 bps to now was the right place, the recalibration phase is now over

·         I saw this as a close call

·         The data on inflation are coming in showing slowed progress relative to what we wanted; it's bumpy

·         Risks to the outlook are equally balanced

·         I think we have a policy in a good place, prepared for what is before us

·         We don't know what the incoming administration will do so for me it's about the data

·         Some firms seem to be building inventory because of caution

·         I feel the positive sentiment among firms is giving us cautious enthusiasm

·         I don't see rate hikes as among the salient risks right now

·         We might end up with fewer cuts than 2 or more than 2 if the labor market weakens notably

On 21st December, there were some reports about the Fed’s VC Barr:

·         Fed's Barr has sought legal advice amid speculation that Trump might want to remove him – sources

·         Barr is worried. He was appointed in 2022 for a term that lasts until 2032 but is worried that Trump may try to remove him

On 20th December, Fed’s Goolsbee said:

·         Recent inflation has been higher than expected; for sure bumps can happen and policy uncertainty, but it's clear inflation is heading toward 2%

·         The last 6 months of PCE inflation is very close to 2%

·         The wide consensus at the Fed is that the long-run neutral rate is well below where the policy rate is now

·         The rate path will be determined by employment and prices

·         Rates will come down by a judicious amount next year

·         Rates will go down next year

·         The uncertainty on policy is part of why I feel the rate next year is a bit more shallow.

·         Our job is to think through scenarios, though we don't know what the new administration will propose.

·         I think rates come down a fair bit more

·         I agree policy rate is still far from a neutral rate

·         I agree policy rate is meaningfully restrictive

·         Employment is stable, want to keep it stable, to do so, rates need to come down to something like a neutral

·         In the next 12 to 18 months, rates can go down a fair amount

·         My projections were for a slightly more shallow rate path in 2025

·         There's more uncertainty and noise

·         Still, on the path to getting to 2% inflation, today's data shows recent firming was a bump

·         It's nice to get an inflation number that's better than expected

On 20th December, Cleveland Fed’s President Hammack said:

·         The rate cut was a 'close call' and I favored holding policy steady

·         I would prefer to see more progress on prices before cutting

·         The balance of risks is skewed toward higher inflation risks

·         Inflation is elevated and progress to 2% is uneven

·         A strong job market allows the Fed to focus on lowering inflation

·         Dissented because data supported holding the Fed policy steady

Full text of statement by Fed’s Hammack, explaining her dissent in Dec’24 FOMC meeting:

“The US economy is in a good position, but there is more work to do on inflation. Economic growth has been strong, and the labor market is healthy. Broad measures of financial conditions have eased, and business sentiment remains robust. Monetary policy has played an important role in bringing PCE inflation down considerably from its peak of 7.2 percent in the summer of 2022. Despite these positive developments, inflation remains elevated, and recent progress in returning inflation to 2 percent has been uneven.

Given the health of the labor market, it is important to maintain the focus on returning inflation to 2 percent in a timely fashion. To accomplish this objective, I believe that monetary policy will need to remain modestly restrictive for some time. Based on my estimate that monetary policy is not far from a neutral stance, I prefer to hold policy steady until we see further evidence that inflation is resuming its path to our 2 percent objective.

In my mind, maintaining the target range for the federal funds rate at 4-1/2 to 4-3/4 percent at the December 2024 meeting was the best choice given the strength of recent economic data, accommodative financial conditions, and my forecast that inflation will remain somewhat above 2 percent over the next year amid a healthy labor market.

The economy’s momentum and recent elevated inflation readings caused me to revise my inflation forecast for next year. In addition, the balance of risks to the outlook appears to be skewed toward higher inflation outcomes. A stall in inflation above 2 percent for too long would risk de-anchoring inflation expectations, making it harder to return inflation to our objective.

I viewed my own decision as a close call, and I appreciate the diverse perspectives that my FOMC colleagues brought to our robust discussion. I look forward to continuing to collaborate with my FOMC colleagues in service to the American public as we seek the best course for monetary policy to achieve our dual mandate objectives of maximum employment and price stability.”

On 20th December, the NY Fed President Williams said:

·         The baseline trajectory is for more rate cuts based on data

·         A higher productivity rate may have lifted the neutral rate a bit

·         I don't think we're at a long-run neutral rate now

·         The Fed is still in a restrictive stance of policy and is above neutral rate

·         Our economy is doing well and that's pushed up longer-term yields

·         I expect the slowdown in labor force growth to continue

·         There is a lot of uncertainty around future fiscal policy

·         There is a lot of uncertainty around inflation

·         We have seen good progress on inflation, but recent data is a touch higher

·         The Fed will have to be data-dependent as it sets policy

·         Monetary policy is well-positioned and is somewhat restrictive

·         For the next year expects growth to slow to 2%, steady unemployment rate

·         The economy is in a good place

·         The recent data consistent with the Fed's economic projections

·         We will make sure the Fed gets inflation to 2%

·         I am seeing encouraging news on the economy but the journey has been bumpy

Conclusions:

Although the Fed generally talks about 2.0% PCE inflation as a price stability target, in reality, it maintains 1.5% core/total PCE inflation and 2.3% core/total CPI inflation; i.e. around 1.9% average inflation (PCE+CPI) targets, Congress has entrusted along with maximum employment 96.0-95.5% of the labor force; i.e. 4.0-3.5% headline unemployment rate. Fed will now try to bring down average core inflation from around 3.0% to 2.5% by keeping the unemployment rate at least around 4.0% by December’25 and then 2.0% core inflation and 3.5% unemployment rate by December’26 to achieve its mandate of maximum employment and price stability.

As US core inflation almost stalled in H2CY24 around +3.0% on average, while the unemployment rate remains stable at around 4.0% along with resilient Real GDP and PDPF growths around 2.8-3.0% on average, the Fed should have paused in December to asses more data and Trump policies on inflation and employment. But the Fed cut -25 bps in Dec’24 too (after September and November) to make up for previous policy mistakes and be able to be ahead of the curve despite core disinflation almost stalled in H2CY24, while the unemployment rate remains stable around 4.0% and economic activity remains resilient.

 

Despite unfavorable data, and Trump policy uncertainty Fed cut on 18th December’24 to catch up with synchronized global easing and also to keep differential with ECB, which cut -100 bps in 2024. Fed may have also made a policy mistake by not cutting rates by 50 bps in H1CY24 and thus now cutting 100 bps in H1CY24 to catch up.

As per Taylor’s modified rule, considering the desired real REPO rate of +1.0%, core CPI inflation targets of +2.3%, unemployment targets of 3.5%, and real GDP growth targets of 3.0% and expected 2024 average levels, the Fed should cut REPO rate from present +4.50% to 4.00% by Dec’25. Fed may like to keep the repo rate at 4.5% against average core CPI inflation for 2024 around 3.5% for a real repo rate +1.0%, moderately restrictive, but lower than 2.0% in H1CY24, when the repo rate was 5.50% against average core CPI inflation +3.5%. Looking ahead, the Fed may like to keep the core real rate around +1.00% and cut gradually every six months till Dec’27 for a repo rate of +3.00% from +4.50% at present.

Thus the Fed cut on 18th December for a cumulative rate cut of 100 bps in 2024 to a repo rate of 4.50% against the average core CPI of 3.5% for 2024, so that the real repo rate remains around +1.00%. Fed may have made a policy mistake by not cutting from H1CY24 when 3MRA of core CPI was around +3.5% on average. Thus Fed is now cutting 50 bps extra in H2CY24 to stay ahead of the curve.

Despite a 50 bps projected rate cut in 2025-26, the Fed may cut 100 bps each if Trump’s immigration and tariff policies are less hawkish in reality due to moderate Musk & Co., who may ensure good relations between Trump/US with China and Russia (Putin); Musk has not only good business relation with China but also a good ‘personal/diplomatic’ relation with Putin for the last few years.

Fed front-loaded 50 bps rate cuts for 2025 in H2CY24 and thus may cut only 50 bps in 2026. But the Fed may also change its stance in the coming months and go for 100 bps rate cuts in 2025 if the US unemployment rate ticked up towards 4.5%, while core CPI inflation ticked down below +3.0%. We have to keep in mind Fed often changes its goalposts to suit its narrative/stance/rate action even after contradictory jawboning. The Fed should maintain more credibility as the Fed is the de-facto central bank of the world and controls almost all types of financial asset classes, with USD being the undisputed preferred global trade & reserve currency.

In H1CY25, the Fed may also share some concrete plans to end the QT, which may be positive for UST and negative for US bond yields, USD. Fed is now cutting rates while doing QT, which is two contra monetary policy tools. As a result, bond yields remain elevated at around 4.50% and the real economy may not be getting the full effect of a 100 bps rate cut in 2024. The market usually discounts Fed rate cuts well in advance in line with regular Fed talks and official dot plots.

Thus Fed may close the QT first by June’25 at B/S size around $6.60-6.50T from present levels of around $6.89T. Fed may keep the B/S size around 22% of projected nominal GDP around $30T by 2025, which may be an ideal level for the Goldilocks nature of the US economy and may not cause another REPO/Funding market crisis as we have seen late 2019 under Trump and Powell-1.0.

Bottom line:

Fed may first close QT by June’25 and then resume the rate cut cycle for 50 bps cumulative in 2025. But the Fed also changes its narrative/goalposts quite frequently and thus its credibility is now at stake. Overall, the Fed now has to bring core inflation (PCE+CPI average) from present levels of 3.0% to 2.0% and unemployment rate from the present average around 4.0% to 3.5% by Dec’27 to declare victory for its dual mandate of minimum price stability and maximum employment.

Market Impact:

Wall Street Futures slid Friday on year-end (CY24) on fading hopes of the next rate cut in March’25 and also profit booking led by techs, after the recent Santa rally. Although the market is now still expecting three rate cuts of @25 bps cumulating 75 bps in 2025 (March + June September), the Fed may cut only two times cumulating 50 bps (June + December).

On Friday, Wall Street was dragged by all eleven major sectors led by consumer discretionary, techs, communication services, real estate, financials, industrials, consumer staples, materials, healthcare, utilities, and energy to some extent. Scrip-wise, Wall Street was dragged by Nvidia. Microsoft, Amazon. Tesla, Apple, and Walmart, while boosted by Boeing and Chevron to some extent.

On Friday, The S&P 500 slumped 1.1%, the Nasdaq 100 slid 1.3%, and the Dow Jones Industrial Average (DJ-30) lost 333 points (-0.90%), snapping a 6-session winning streak. Despite Friday’s losses, the S&P 500 and Nasdaq posted weekly gains of 1.6%, while the Dow added 1.4%, supported earlier by the S&P 500's best Christmas Eve performance since 1974.

Rising Treasury yields, with the 10-year yield nearing a seven-month high of 4.6%, added pressure on equities. Investors are now shifting their focus to 2024, eyeing the Fed’s interest rate strategy and the potential implications of Donald Trump’s return to the White House. Markets have digested the year's key data, with expectations now set on rate cuts potentially beginning in May as the Fed balances inflation and a cooling labor market.

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

Looking ahead, whatever the fundamental narrative, technically Dow Future (CMP: 43650) now has to sustain over 43900-44200 for any further rally to 45000/45500 and further 45800/46000-46200/46400 and 46800/47000-47500/48000 in the coming days; otherwise sustaining below 43800, DJ-30 may again fall to 43300/43000-42600/41500 in the coming days.

Similarly, NQ-100 Future (21950) has to sustain over 22300 for a further rally to 22500/22700-23000/23300 in the coming days; otherwise, sustaining below 22300, NQ-100 may again fall to 21600/21400 and 20950/20850-20500/20300 and 20000/19800-19650/19350 in the coming days.

Technically, SPX-500 (CMP: 6090), now has to sustain over 6200 for any further rally to 6350/6500 in the coming days; otherwise, sustaining below 6150-6050 may again fall to 6000/5950-5900/5850 and 5675/5600-5550/5500 in the coming days.

Also, technically Gold (CMP: 2630) has to sustain over 2655-2680 for a recovery to 2700-2725 and further 2735/2750-2775/2795 and 2815 in the coming days; otherwise sustaining below 2650-2640 may again fall to 2605/2600 and 2590/2565 and further fall to 2550/2500-2470/2450 in the coming days (depending upon Fed rate cuts, Gaza/Ukraine war trajectory); Gold surged almost 75% in the last one year since Gaza war started back in October’23. Now it may retrace to $2100 levels if Trump indeed can mediate both Gaza and Ukraine war ceasefire by early 2025.