Dow, Gold surged on less hawkish Powell talks and soft CPI

·        After June, the 6M RA of core CPI was 3.6%; at present R/R, it may not hit 3.0% before Dec’24 and till then Fed may not be confident enough for rate cuts

On Tuesday, Wall Street closed mixed on fading hopes of an early Fed pivot coupled with AI/Nvidia optimism and the never-ending Boeing issues. But Banks & financials surged on the Fed’s delaying tactics for Dodd-Frank and BASEL-III regulatory norms. Additionally, Gold slid after China/PBOC reported no buy in June after buying none in May. Also, lingering suspense about the Gaza war ceasefire is buoying and undercutting Gold (roller coaster move).

On Wednesday, Fed Chair Powell said in his 2nd day of Congressional (House) Testimony:

·         A policy rate cut is not appropriate until the Fed gains greater confidence inflation is headed sustainably toward 2%

·         We have made considerable progress toward the 2% inflation goal, recent monthly readings show modest further progress

·         Elevated inflation is not the only risk we face

·         It feels like the policy is restrictive, but not intensively restrictive, that suggests neutral rate is a little higher than before

·         We need to be mindful of the labor market, I have seen considerable softening there.

·         As I've said, there is a path to price stability while keeping unemployment now.

·         I do have some confidence in inflation coming down but I am not prepared to say I am sufficiently confident in it coming sustainably down to 2% yet.

·         I do have some confidence that inflation is headed lower

·         We want to have greater confidence, which means more good inflation readings

·         You don't want to wait until inflation gets to 2% to ease policy

·         The Fed has made quite a lot of progress on inflation

·         The economy is growing around 2% it feels like, and with inflation and jobs, these are good numbers

·         The Fed wants to be more confident about inflation

·         We see current Fed policy as restrictive

·         We have a good ways to go on shrinking the balance sheet

·         I don't think shrinkflation is a major inflation driver

Overall, on Wednesday on his 2nd day of Congressional Testimony (House), Powell sounded or seemed to sound less hawkish than on his 1st day of Testimony (Senate) as Powell said now he has some confidence in disinflation, but not enough confidence to going for the start of rate cuts. In brief, like in the Senate Tuesday, ahead of the Nov’24 election, Powell was again grilled in the House Wednesday for still elevated inflation affecting ordinary Americans (general public), who is the largest vote bank for any political party (Democrats and Republicans). Although  Powell acknowledged elevated inflation (still almost +20% up from pre-COVID levels against normal +10% in 4-5 years),

Powell also pointed out that even at the 4.1% headline unemployment rate (3.9% 6M rolling average), because of the Fed, it’s still well below the historically higher unemployment rate of 4.5% (Fed red line). Thus Fed has still space to keep a higher restrictive rate to produce more slack in the economy to bring inflation down. Although Powell was under pressure from some Democrats for the start of rate cuts by July/Sep’24, just before the Nov’24 US election, Powell was adamant about sounding politically neutral and made it clear that as an independent central bank, the Fed will only go by economic data and outlook rather than any political/election calendar.

Ahead of the US Nov’24 election, both Democrats and Republicans are trying to score on politically sensitive issues like the recent surge in immigration, unaffordable housing, and its effect on inflation and employment. Although higher immigration has helped to cool the US labor market in the last two years by adding more supply of workers (skilled/unskilled), it’s also creating fresh/higher demands for goods & services including housing/renting and causing more inflation (increasing demand vs constrained supply).

Thus to serve an increasingly bigger economy, the US has to increase the supply capacity of the economy, especially both social (education, healthcare) & traditional/transport infra including a wide network of high-speed railways and smart cities (like in China) to meet growing demand of the population and balance/reduce inflation.

But most of the time, the Ruling Party in the White House is a minority government and there are various issues for a common bipartisan agreement for such infra spending; Democrats are usually more infra savvy, while Republicans are almost the opposite, relying on more tax cuts. As per some reports, Trump may even end the income tax in the US and instead go for higher VAT/sales tax rates of 35% (?) in the US! As usual, Powell was heavily grilled by both sides of the aisle (Democrats and Republicans)  for his comments on infra stimulus, higher debts, and the housing problem of the US economy, Powell chose most of the time to not comment on such politically sensitive issues to sound/look politically neutral.

As the flood of immigrants is now a political/election issue, many US Lawmakers also pointed out Fed should allow higher wage growths to bring back around 7M of US native workers from the sideline to encourage them to join the active labor force rather than receiving dole money (unemployment benefits) lifelong. But Powell clearly said immigration, and fiscal/infra stimulus issues are with the government, not the Fed’s.

Fed’s Monetary Policy Report – July 2024:

Monetary Policy Report submitted to the Congress on July 5, 2024, pursuant to section 2B of the Federal Reserve Act

Inflation eased notably last year and has shown modest further progress so far this year, but it remains above the Federal Open Market Committee's (FOMC) objective of 2 percent. Job gains have been strong, and the unemployment rate is still low. Meanwhile, as job vacancies continued to decline and labor supply continued to increase, the labor market moved into a better balance over the first half of the year. Real gross domestic product (GDP) growth was modest in the first quarter, while growth in private domestic demand remained robust, supported by slower but still-solid increases in consumer spending, moderate growth in capital spending, and a sharp pickup in residential investment.

The FOMC has maintained the target range for the federal funds rate at 5-1/4 to 5-1/2 percent since its July 2023 meeting. In addition, the Committee has continued to reduce its holdings of Treasury securities and agency mortgage-backed securities. The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. Reducing policy restraint too soon or too much could result in a reversal of the progress on inflation. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.

The FOMC is strongly committed to returning inflation to its 2 percent objective. The Committee remains highly attentive to inflation risks and is acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials.

Recent Economic and Financial Developments

Inflation:

Although personal consumption expenditures (PCE) price inflation slowed notably last year and has shown modest further progress this year, it remains above the FOMC's longer-run objective of 2 percent. The PCE price index rose 2.6 percent over the 12 months ending in May, down from the 4.0 percent pace over the preceding 12 months and a peak of 7.1 percent in June 2022.

The core PCE price index—which excludes food and energy prices and is generally considered a better guide to the direction of future inflation—also rose 2.6 percent in the 12 months ending in May, down from 4.7 percent a year ago and slower than the 2.9 percent pace at the end of last year. On a 12-month basis, core goods price inflation and housing services price inflation continued to ease over the first part of the year, while core non-housing services price inflation flattened out after slowing notably last year. Measures of longer-term inflation expectations are within the range of values seen in the decade before the pandemic and continue to be broadly consistent with the FOMC's longer-run objective of 2 percent.

The labor market:

The labor market continued to rebalance over the first half of this year, and it remained strong. Job gains were solid, averaging 248,000 per month over the first five months of the year, and the unemployment rate remained low. Labor demand has eased, as job openings have declined in many sectors of the economy, and labor supply has continued to increase, supported by a strong pace of immigration.

With cooling labor demand and rising labor supply, the unemployment rate edged up to 4.0 percent in May. The balance between labor demand and supply appears similar to that in the period immediately before the pandemic, when the labor market was relatively tight but not overheated. Nominal wage growth continued to slow in the first part of the year but remains above a pace consistent with 2 percent inflation over the longer term, given prevailing trends in productivity growth.

Economic activity:

Real GDP growth is reported to have moderated in the first quarter after having increased at a robust pace in the second half of last year. Much of the slowdown was due to sizable drags in the volatile categories of net exports and inventory investment; growth in private domestic final purchases—which includes consumer spending, business fixed investment, and residential investment—also moved a little lower in the first quarter but remained solid.

Real consumption growth slowed in the first quarter from a strong pace in the second half of last year, reflecting a decline in goods spending. Real business fixed investment grew at a moderate pace in the first quarter despite high interest rates, supported by strong sales growth and improvements in business sentiment and profit expectations. Activity in the housing sector picked up sharply in the first quarter as a result of a jump in existing home sales and the rising construction of single-family homes.

Financial conditions:

Financial conditions appear somewhat restrictive on balance. Treasury yields and the market-implied expected path of the federal funds rate have moved up, on net, since the beginning of the year, while broad equity prices have increased. Credit remains generally available to most households and businesses but at elevated interest rates, which have weighed on financing activity. The pace of bank lending to households and businesses increased in the first five months of the year but continues to be somewhat tepid. Delinquency rates on small business loans stayed slightly above pre-pandemic levels, and delinquency rates for credit cards, auto loans, and commercial real estate loans continued to increase in the first quarter of 2024 to levels above their longer-run averages.

Financial stability:

The financial system remains sound and resilient. The balance sheets of nonfinancial businesses and households stayed strong, with the combined credit-to-GDP ratio standing near its two-decade low. Business debt continued to decline in real terms, and debt-servicing capacity remained solid for most public firms, in large part due to strong earnings, large cash buffers, and low borrowing costs on existing debt. However, there were also signs of vulnerabilities building in the financial system. In asset markets, corporate bond spreads narrowed, equity prices rose faster than expected earnings, and residential property prices remained high relative to market rents.

Moreover, in the banking sector, some banks' fair value losses on fixed-rate assets remained sizable, despite most of them continuing to report solid capital levels. Additionally, parts of banks' commercial real estate portfolios are facing stress. Some banks' reliance on uninsured deposits remained high. Even so, liquidity at most domestic banks remained ample, with limited reliance on short-term wholesale funding. Bond mutual funds' exposure to interest rate risk stayed elevated, and data through the third quarter of 2023 show that hedge fund leverage had grown to historical highs, driven primarily by borrowing by the largest hedge funds.

International developments:

Foreign economic activity appears to have improved in the first quarter after a soft patch in the second half of last year. In advanced foreign economies, growth rates returned to moderate levels despite the effects of restrictive monetary policy as lower inflation improved real household incomes. In emerging market economies, growth was supported by a recovery in exports and rising global demand for high-tech products, with the rise in activity in China in the first quarter being particularly outsized. Nonetheless, other factors continued to weigh on economic growth: Data indicated ongoing weakness in China's property sector, and in Europe, energy-intensive sectors continue to struggle, reflecting their ongoing adjustment to past increases in energy prices following Russia's 2022 invasion of Ukraine.

Foreign headline inflation has continued to decline since the middle of last year, but the pace of disinflation has been gradual and uneven across countries and economic sectors. Still, many foreign central banks have noted this progress in lowering inflation, and some have begun to cut their policy rates. A notable exception is Japan, which ended its negative interest rate policy and yield curve control in March amid persistently high inflation. The trade-weighted exchange value of the dollar rose significantly, consistent with widening gaps between U.S. and foreign interest rates.

Monetary Policy

Interest rate policy:

The FOMC has maintained the target range for the policy rate at 5-1/4 to 5-1/2 percent since its July 2023 meeting. The Committee judges that the risks to achieving its employment and inflation goals have moved toward better balance over the past year. The Committee perceives the economic outlook to be uncertain and remains highly attentive to inflation risks. The Committee has indicated that it does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent. Policy is well positioned to deal with the risks and uncertainties the Committee faces in pursuing both sides of its dual mandate. In considering any adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.

Balance sheet policy:

The Federal Reserve has continued the process of significantly reducing its holdings of Treasury and agency securities predictably. Beginning in June 2022, principal payments from securities held in the System Open Market Account have been reinvested only to the extent that they exceeded monthly caps. Under this policy, the Federal Reserve has reduced its securities holdings by about $1.7 trillion since the start of the balance sheet reduction.

The FOMC has stated that it intends to maintain securities holdings at amounts consistent with implementing monetary policy efficiently and effectively in its ample-reserves regime. To ensure a smooth transition from abundant to ample reserve balances, the FOMC slowed the pace of decline of its securities holdings at the beginning of June and intends to stop reductions when reserve balances are somewhat above the level that the Committee judges to be consistent with ample reserves.

Special Topics

Housing services inflation:

The PCE price index for housing services started accelerating in 2021, notably increasing its contribution to core PCE inflation. Because this index calculates average rent for all tenants—both new tenants and existing tenants—its changes tend to lag changes in market rent measures for new leases. Therefore, measures of market rent growth for new leases can help predict future changes in the PCE price index. Since mid-2022, market rents have decelerated and returned to a growth rate similar to or below their average pre-pandemic pace, while the PCE index continues to show elevated inflation, reflecting the gradual pass-through of market rates to existing tenants. As this process continues, PCE housing services inflation should gradually decline, though much uncertainty remains about the extent and timing.

Employment and earnings across groups:

A strong labor market over the past two years has been especially beneficial for historically disadvantaged groups of workers. As a result, many of the long-standing disparities in employment and wages by sex, race, ethnicity, and education have narrowed, and some gaps reached historical lows in 2023 and the first half of 2024. However, despite this narrowing, significant disparities in absolute levels across groups remain.

Monetary policy independence, transparency, and accountability:

Congress has established a statutory framework that specifies the long-run objectives of monetary policy—maximum employment and stable prices—and gives the Federal Reserve operational independence in conducting monetary policy. In this framework, the Federal Reserve makes determinations about the monetary policy actions that are most appropriate for achieving the dual-mandate goals that Congress has assigned to it.

The Federal Reserve recognizes that independence is a trust given to it by Congress and the American people and that with independence comes the need to be transparent about, and accountable for, its monetary policy decisions. Transparency also improves monetary policy's effectiveness. The Federal Reserve promotes transparency by providing information about FOMC decisions through policy communications and a variety of publications. The means by which the Federal Reserve informs the American people about its monetary policy decisions include official FOMC statements, monetary policy reports, and Committee meeting minutes and transcripts, as well as speeches, press conferences, and congressional testimony given by Federal Reserve officials.

Federal Reserve's balance sheet and money markets:

The size of the Federal Reserve's balance sheet has continued to decrease since February as the FOMC has reduced its securities holdings. Reserve balances, the largest liability on the Federal Reserve's balance sheet, and usage of the overnight reverse repurchase agreement facility—another Federal Reserve liability—both declined.

Monetary policy rules:

Simple monetary policy rules, which prescribe a setting for the policy interest rate in response to the behavior of a small number of economic variables, can provide useful guidance to policymakers. With inflation easing over the past year, the policy rate prescriptions of most simple monetary policy rules have decreased recently and now call for levels of the federal funds rate that are close to or below the current target range for the federal funds rate.

Market impact:

On Wednesday, Wall Street Futures and also Gold got some boost after less hawkish Powell comments, but Gold eventually slipped as the overall Fed stance remains the same for the time being; i.e. wait & watch. Although Powell said he has now some confidence about the disinflation process, he is not confident about going for rate cuts and thus he/Fed will be in wait-and-watch mode for the next few months. But Dow was also boosted by banks & financials as Powell downplayed or again delayed Dodd-Frank and BASEL-III regulatory norms.

On early Thursday, Wall Street Futures and Gold surged on softer-than-expected total CPI and also the core CPI rate for June (to some extent). But the Fed will go by core CPI, which came at +3.3% in June from +3.4% sequentially; the 6M rolling average of core CPI is now at +3.6% and present trend, it may fall to around +3.0% by Dec’24, when Fed may feel enough confidence for starting the 11 rate cuts cycle from Dec’24, not Sep’24.

Bottom line: Summary

·         Fed may not cut rates before Nov’24 US election despite some pressure from Democrats.

·         Fed may not cut rates at all from Sep’24, just months before Nov’24 US election to avoid any political controversy, and may cut rates in Dec’24

·         In the Sep’24 Fed meeting, the Fed may say it gets ‘confidence’ for going for rate cuts from Dec’24 to keep both Democrats and Republicans as well as Wall Street and also Main Street; bond yield should slip.

·         One month of weak/strong job data may not change the Fed’s narrative about higher for longer stance as the 6M rolling average of headline unemployment at 3.9% average is still below 4.5%, while core CPI inflation is still around +3.7%, above +3.0% Fed’s confidence levels.

·         The Fed may start the long-awaited eleven rate cut cycle from Dec’24 and may also indicate the same by Sep-Oct ’24.

·         The Fed will be in ‘wait & watch’ mode till at least Dec’24. But at the same time Fed will continue its jawboning (forward guidance) to prepare the market to ensure the official dual mandate (maximum employment, price stability) along with an unofficial mandate to ensure financial stability (Wall Street and bond market); Fed may not allow core real bond yield (10Y) above +1.0% under any circumstances to manage government borrowing costs.

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

·         Whatever the narrative, technically Dow Future (39400) has to sustain over 39500-39850 for any further rally to 40050*/40200-40350*/40500 and may further rally to 40600-40700/41000 and even 42000-42700 in the coming days; otherwise, sustaining below 39800/39600-39400/39200 may again fall to 39000/38800-38600/38400 and further 38200/38100-37900*/37600-37400 in the coming days.

·         Similarly, NQ-100 Future (20250) has to sustain over 20350-20500* for a further rally to 20700-21050 in the coming days; otherwise, sustaining below 20450-20300 may again fall to 20000/19850-19750/19650* and 19450/19100-18800/18500 and 18400/18100-18000/17700 and 17600/17500-17300/17150 in the coming days.

·         Technically, SPX-500 (5560), now has to sustain over 5650 for any further rally in the coming days; otherwise, sustaining below 5625/5600-5575/5550 may again fall to 5500/5450-6375/5350 and 5250/5200-5175/5100 and further 5000/4900*-4850/4825 and 4745/4670-4595/4400* in the coming days.

·         Also, technically Gold (XAU/USD: 2325) has to sustain over 2350-2365 for a further rally to 2375/2385-2395*/2400 and further to 2410/2425-2435/2455* and 2475-2500; otherwise sustaining below 2345-2320, may further fall to 2290/2275* and may further fall to 2245/2230-2220/2180 and 2155/2115-2085/2045 in the coming days.