Wall Street soared from stalled core disinflation panic low

·         Techs helped by Nvidia boost; earlier Dow Future tumbled on fading hopes of 50 bps rate cut on 18th September after core CPI stalled in August

·         The 6MRA of US core inflation (CPI+PCE average) may be around +3.0% by Aug’24 and +2.9% by Dec’24; Fed may cut -25 bps each in Sep and Dec’24 to keep real repo rate around +2.0% (restrictive)

·         Gold is under pressure on fading hopes of jumbo/back-to-back Fed rate cuts and progress of Gaza war ceasefire, but increasing Russia-Ukraine war headlines also boosting it

Wall Street Futures were already under pressure on fading hopes of a jumbo Fed rate cuts (-50 bps) in September amid mixed US NFP/labor market data and less dovish Fed talks, indicating the Fed may proceed with an orderly rate cut every quarter end in line with actual incoming economic data and outlook thereof rather than any jumbo rate cuts or panicky back-to-back rate cuts in every meeting (like BOC has done recently).

Fed indicating that although the US labor market is cooling or normalizing gradually from a very hot state last year, it’s still robust and 6MRA of the unemployment rate is now hovering around 4.0% against the preferred range 3.5-4.5% (the min-max unemployment rate for Fed), while that of core inflation (PCE+CPI) is around +3.0% against preferred range (2.0-3.0%). Thus to balance the dual mandate of the Fed; i.e. maximum employment (96.5% of the labor force) and minimum price stability (+2.0% core inflation) on a durable basis, the Fed needs to cut its present restrictive stance in an orderly/balancing way rather than panicky (bizarre) implied probability of stimulus addicted Wall Street FFR movement.

Wall Street was also under stress amid increasing regulatory hurdles for high-end AI Chips export (led by Nvidia) to so-called enemy or less friendly countries (like China, and Saudi Arabia) and disappointing Apple launch for its latest iPhone/iWatch models. Apple was also under pressure after the company lost a court battle over a $14B tax bill by Irish authorities.

Also subdued guidance by some market analysts for JPM and other banking stocks has undercut Wall Street. Although techs helped Wall Street Tuesday to some extent amid an upbeat report card by Oracle (earnings/guidance beat, and an agreement with Amazon web services). Wall Street Futures also come again under stress early Asian/European Wednesday, on fading hopes of Trump 2.0 (tax cut stimulus) after a disappointing performance by Trump in the Presidential Election debate against Democrat candidate Harris. But Harris's victory may be also good for Wall Street as there will be no Trump trade tantrum and policy continuity.

However, Fed Chair Powell also indicated Fed may be inching closer to the launch of eleven rate cut cycles. Fed/Chair Powell is now under huge pressure from financial journalists for rate cuts amid some signs of an economic slowdown and thus the market is now expecting --100 bps rate cuts cumulatively in September, November, and December.

On Wednesday, all focus of the market was on U.S. inflation data for August as it may influence the Fed's decision for any jumbo/normal rate cut action/overall policy stance change in September including SEP/dot-plots. On Wednesday, the BLS data (NSA) showed the annual (y/y) US core CPI inflation increased by +3.2% in Aug’24 from +3.2% sequentially; i.e. unchanged in line with the market consensus of +3.2% and at the lowest over three years (since Apr’21), but still substantially over Aug’19 (pre-COVID) levels of +2.4%. On August 24, the annual core US CPI was boosted by shelter, MV insurance, medical care, recreation, and education.

On Wednesday, the BLS data (SA) showed the sequential (m/m) US core CPI increased +0.3% in Aug’24 from +0.2% in the preceding month, above the market expectations of +0.2%. In August, the sequential core CPI was boosted by transportation services, shelter, and apparel. The Aug’24 core sequential CPI was almost the same as in Aug’19 at around +0.3%.

Overall, the average of US core CPI edged down at +3.5% in 2024 (YTM) against +4.8% in 2023, and +6.2% in 2022, while the 6M rolling average was around +3.4% (y/y) in Aug’24, eased from the prior +3.5%. Still substantially above the Fed’s +2.0% targets and +3.0% levels, below which the Fed may feel confident enough to go for eleven rate cuts cycle. As per the current run rate, if the Sep’24 core CPI sequential rate comes again around +0.20 or +0.30%, then the annual rate would be +3.2% or +3.3%.

The U.S. Core service inflation (w/o energy service) is also unchanged at +4.9% in Aug’24 from +4.9% sequentially and Jan’23 reading of +7.2%, but it’s still substantially above pre-COVID average levels of 2.8%. The Fed is now closely focusing on core service inflation, which is still quite elevated and sticky led by Shelter/Housing inflation amid higher demand for housing an increasing number of immigrant workers (increasing population), and the legacy issue of lack of adequate supply of affordable housing in the US.

Unlike China, the US is unable to create affordable smart cities and high-speed railways for the increasing population due to a lack of political bipartisan consensus between Democrats and Republicans. The US is suffering long from political & policy paralysis to increase the supply capacity of the economy to serve increasing demand and balance inflation. Moreover, now homeowners are not ready to accept lower rent due to higher demand and higher borrowing costs (home/mortgage loans).

In Aug’24, the US Shelter inflation edged up to +5.2% from +5.1% sequentially.

Also, US rent inflation ticked up to +5.2% in Aug’24 from +5.1% sequentially and remains substantially above +3.4% levels in Aug’19 (pre-COVID times).

On Wednesday, the BLS data (NSA) showed the annual (y/y) US total CPI inflation slips to +2.5% in Aug’24 from +2.9% sequentially, below the median forecasts of +2.6%, and the lowest since Feb’21. In Aug’24, the US CPI was dragged by Energy (mainly due to gasoline, fuel oil, and NG), food, transportation, new vehicles, and used cars and trucks to some extent, while boosted by shelter and apparel.

On Wednesday, the BLS data (SA) showed the sequential (m/m) US CPI edged up at +0.2% in Aug’24 from +0.2% in the prior month (unchanged) and in line with market expectations of +0.2% advance. In Aug’24, the sequential US was boosted by shelter, airline fares, motor vehicle (MV) insurance, education, apparel & food, while dragged by energy, used cars & trucks, household furnishings and operations, medical care, communication, and recreation.

Overall, the 6M rolling average (6MRA) of US CPI was +3.1% in Aug’24 against +3.1% in the prior month and a yearly average of +4.1% in 2023, while still substantially above the Fed’s target of +2.0%; officially US Congress has given Fed price stability mandate as 2% CPI on a sustainable basis; not core CPI or core PCE and even total PCE inflation. However, the Fed usually takes the average of core PCE and core CPI inflation for any policy stance as core inflation generally gives a fair picture of underlying inflation; also there is a difference of around 50 bps between core CPI and core PCE inflation. But ordinary Americans are now concerned with higher cost of living expenses, which is total CPI, and thus ahead of the US election, both Democrats and Republicans are now grilling Fed/Powell for still elevated inflation, almost +20% high from pre-COVID levels, which has become an election issue.

At present trend, the 6MRA of core CPI may further fall below +3.0% by Nov-Dec’24, when the Fed may feel enough confidence to go for the next rate cut after Sep’24 (@-25 bps

At present sequential R/R or trend of core CPI, the US core PCE inflation for Aug’24 may come around +2.8% or +2.7% against +2.6% in June’24, while the average core inflation (PCE+CPI) may also remain around +3.0% in Aug’24 against Fed’s target +2.0% on a sustainable basis.

Conclusions:

After Aug’24, the 6MRA of US core inflation (CPI+PCE) would be around +3.0%, the unemployment rate of 4.0% against a target of +2.0% (core inflation-price stability) and 3.5% (maximum employment-unemployment rate). As US core CPI data for Aug’24 does not surprise on the upside, the Fed may start the eleven QTRs rate cut cycle from Sep’24 by cutting -25 bps each QTR end for in H2CY24, CY25, CY26, and Q1CY27. The Fed may cut -275 bps cumulatively from Sep’24 to Mar 27/June’27 for a terminal/neutral repo rate of +2.75% against average core inflation +2.0% on a durable basis.

In Aug’24, the 6MRA/YTM average of US core CPI inflation was +3.1% against the Fed repo rate +5.5%; i.e. the core real rate was around 2.50%, around the Fed’s maximum range of restrictive/real positive rate band (0.50-2.50%). Thus Fed may cut only -50 bps cumulatively, while the market may be still pricing -100 bps rate cuts in 2024 to some extent.

But unless there is a further surge in core inflation, the Fed may like to keep the real core repo rate at a maximum of +2.0% above 6MRA of core CPI. Similarly, at around 2.25-2.00% of core CPI target levels (6MRA), the Fed may keep the repo rate at 2.75-3.00%, so that the minimum real positive rate stays around 0.50-1.00%. Unless there is another COVID-like extreme financial crisis, the Fed may like to keep the real rate in a positive zone to ensure the Goldilocks nature of the US economy.

Most of the time, a Fed rate hike of around 4.50-5.50% to control inflation has caused the next wave of financial crisis in some form or other. Thus Fed always wants to keep some policy space in hand for use in such emergencies (like during COVID) and thus will keep the rate in real positive zones and also sufficient capacity in the B/S to absorb any QE in the next wave of financial crisis. Fed is now maintaining a real positive rate since June-July’23.

Overall, after various Fed comments Friday, it seems that the Fed will start the rate cut cycle from Sep’24 by cutting -25 bps and not -50 bps as expected by the market to some extent. Fed may join ECB, BOE, and BOC which cut rates just ahead of respective general elections in their jurisdiction/countries. If the US core inflation pace is not stalled completely or not surprisingly edged up, then the Fed may go for rate cuts from Sep’24 for the next 11 QTRs by -25 bps, which may be already discounted by the market by a great extent.

 

Although the Fed usually talks about core PCE inflation targets of around +2.0%, in reality, it targets +1.5% levels of core PCE inflation as core CPI inflation is normally 50-100 bps higher than the core PCE inflation. Ideally, the Fed targets average core inflation (CPI+PCE) of +2.0% and unemployment rate (minimum) around 3.5-3.7%.

The 6MRA of US core inflation (CPI+PCE) may edge down to around +3.0% by Aug’24 from July’24 levels of around 3.1%, while the 6MRA of US unemployment rate was +4.0% till Aug’24. Thus Fed needs to lower US core inflation by another -100 bps and the unemployment rate by -50 bps to fulfill its dual mandate of maximum employment and price stability. By Dec’24, the 6MRA of US core inflation (PCE+CPI) may further fall to around +2.9% and by then the Fed repo rate should be at +5.00% so that the real rate remains around +2.0% (~1.9%).

Looking ahead, the Fed may start cutting rates by -25 bps in Sep’24 and Dec’24 rather than -50 bps to balance dual mandate targets. The present rate of core disinflation (CPI+PCE) is around -0.08% per month, almost 50% of the 2023 average disinflation rate -0.16% per month. If the core disinflation average pace remains the same around -0.08% in the coming months, then the Fed may achieve its +2.0% core inflation targets by Aug’25. However, it may be difficult amid rising RM and shipping costs along with labor wage costs and lower labor supply in 2025.

Thus Fed may cut rates at a gradual pace at -25 bps each QTR end rather than jumbo rate cuts of -50 bps, which may stall and reverse the present disinflation process amid increasing US population; i.e. higher demand of the economy against constrained supply capacity amid lack of appropriate and time fiscal/policy intervention. Also, the Fed may like to keep some monetary stimulus in reserve for usage in the next financial crisis; it may be the AI bubble (like the dotcom bubble) and increasing geopolitical tensions over the Russia-Ukraine and Gaza war (Israel-Iran?).

Bottom line:

Fed may start cutting rates by -25 bps from Sep’24 QTR and may also project similar -25 bps rate cuts each QTR end as below for 2025-26 in its September dot-plots unless there are some signs of the next financial crisis or some real exigencies. Fed will not go for jumbo or any type of back-to-back rate cuts to maintain the Goldilocks nature of the US economy.

Market Impact:

On Wednesday Dow Future plunged from around 40700 to almost 40000 after BLS data showed the last mile of US disinflation may have stalled to some extent, which may keep the Fed for an orderly/gradual rate cut of -25 bps each in every quarter end rather than any -50 bps jumbo or even back-t0-back -25 bps rate cuts in every consecutive FOMC meetings. But later, Dow Future also recovered on short covering and value buying coupled with Nvidia boost after a report that the US may allow the company to export high-end AI chips to Saudi Arabia. Also, positive comments about the outlook of the company/AI chip sector by the Nvidia CEP helped the risk on sentiment.

On mid-Friday, Wall Street Futures recovered and surged to close in deep to moderate green. Gold stumbled from around 2530 to 2500 and then recovered to close around 2515; the progress of the Gaza war ceasefire is also undercutting gold, while some random news of the Russia-Ukraine war also boosted it sometimes briefly. USD, US bond yield surged on fading hopes of jumbo Fed rate cuts. Oil surged on US inventory drawdown hopes and increasing probability of Harris winning in the US election, who may not encourage US fracking (oil production) like Trump.

On Friday, Wall Street Futures were boosted by techs, consumer discretionary, communication services, utilities, materials, and industrials, while dragged by energy, consumer staples, banks & financials, healthcare, and real estate. Scrip-wise, Wall Street was boosted by AI/Chip stocks led by Intel, Nvidia, AMD, Broadcom, SMCI, TSCI, Apple, Microsoft, Amazon, IBM, Honeywell, JPM, Goldman Sachs, Boeing, Caterpillar and SM, while dragged by Travelers, P&G, United Health, J&J, Chevron and Merck. China-savvy stocks surged on the fading concern of Trump 2.0 and the Trump trade war tantrum.

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

Whatever the narrative, technically Dow Future (40970) has to sustain over 41300-41500 for any further rally to 41650/41750*-41950/42100* and 42700/41900-43050/44250-44500/44800 in the coming days; otherwise sustaining below 41200-41000, DJ-30 may again fall to 41900/40700-40500*/40300 and 40150/40000*-39700/39450 and further 39350/39200-39100/38900 and 38500*/38300-38000/37600 in the coming days.

Similarly, NQ-100 Future (18650) has to sustain over 18900/19000-19200/19500 for further recovery and rally to 19800/20050-20200/20300 for any further rally to 20400*/20600-20800/21050* and further to 21300/21700-21900/22050 and even 23000 levels in the coming days; otherwise, sustaining below 18750-18650, NQ-100 may again fall to 18400/18200-17950/17600 and 17450-17300/17000 in the coming days.

Technically, SPX-500 (5475), now has to sustain over 5550 for any further rally to 5575/5675 and 5725/5750*-5850*/5900 and 6000/6050 and 6100/6150 in the coming days; otherwise, sustaining below 5550-5500 may again fall to 5450/5390-5370/5300* and 5250/5100* and further 5050/4950*-4850/4750 and 4550/4450-4350*/3850 in the coming days.

Also, technically Gold (XAU/USD: 2500) has to sustain over 2510 for a further rally to 2520/2530-2540* and 2560*/2575-2600/2650 in the coming days; otherwise sustaining below 2505, may fall to 2490/2480-2460/2445* and 2435/2420-2410/2400 and further to 2375/2350*-2325/2300 in the coming days.