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Gold surged on less hawkish Powell talks, but Dow slid

Gold surged on less hawkish Powell talks, but Dow slid

calendar 19/05/2023 - 21:40 UTC

Wall Street surged on tech and debt deal progress boost Thursday after a volatile day of trading; Dow was also affected by softer jobless claims data and hawkish Fed talks; Gold slumped as Fed may hike in June and the debt deal is almost done! In the early Friday U.S. session, Dow Future made a session high around 33730 from Thursday closing levels of 33600, while Gold made a low around 1957 from a European session high of 1968 on the progress of U.S. debt limit deal talks. But soon, Gold jumped to almost 1985 after Fed’s Chair Powell indicated a pause in June; while Republican (GOP) negotiator for debt limits Graves said talks are at a pause. Banks were also under stress of the concern of another regional bank crisis as the U S Treasury Secretary Yellen told bank CEOs more mergers may be necessary.

On Friday, Fed’s Bowman said:

·         Targeted modifications to banking regulation should be considered, not radical change

·         I am extremely concerned about casting aside tiering of bank regulation and shifting from tailoring in the wrong direction

·         Tailoring bank regulation, and supervision based on the size and risk profile of banks is critical

·         The banking system is robust despite recent stress

·         Repeats the call for the Fed to engage an independent third party to review bank failures including SVB

·         Utilizing bank failures as a pretext to push for unrelated changes to bank regulation should be avoided

On Friday, in a Fed research conclave, NY Fed President and the ‘guru’ of R* (R-Star)-the natural rate of real interest rate (Fed repo rate-average inflation) presented a research article on his favorite subject and said during the Q&A: “It's possible the R-Star estimate could rise again”.

As per NY Fed’s Williams’ chart, the R* (R-Star); i.e. the natural rate of a real interest rate for the U.S. should be above +1%; i.e. if we consider 3M rolling average core inflation (CPI+PCE) of around +5.0% ((5.6+4.6)/2=5.1%)), which is also now (co-incidentally) equal to 3M rolling average of headline CPI (inflation), the ideal terminal repo rate should be +6.00% against present level +5.25%. And after recent series of Fed talks, especially by Bullard, the market was expecting at least another rate hike in June for a terminal rate of +5.50% (middle level of the lower and upper restrictive zone; i.e. 5.00-6.00%) and then a possible pause for rest of the year to assess the full impact of cumulative rate hikes and credit tightening (amid regional/small bank crisis) on the overall economy/consumer spending/demand and inflation.

On Friday Fed’s Chair Powell said in the Fed research conclave (Q&A):

·         Policy rate may not have to rise as far as otherwise due to tightened bank credit conditions

·         The Fed's tools are complementary most of the time, sustainably achieving price stability depends on a stable financial system

·         We have separate tools for monetary policy, financial oversight

·         The banking system is strong and resilient

·         Inflation is far above the Fed's objective

·         Price stability is the foundation of a strong economy and it's the responsibility of the central bank to maintain it

·         There may be continued supply shocks but it is hard to predict

·         For policymakers, central banks are still responsible for price stability regardless of supply shocks

·         Developments in the banking sector mean policy rate may not need to rise as much to achieve policy goals

·         Positive supply shocks during globalization perhaps did help keep inflation low

·         Inflation in Non-housing services particularly susceptible to labor outcomes

·         The labor market slack did not figure into early inflation, but I do think labor slack will be a factor in inflation going forward

·         The relationship between labor market slack and inflation is not different from before the pandemic

·         Inflation may be more responsive to changes in the jobs market

·         Guidance today is limited to assessing conditions that might warrant further firming

·         Until recently clear further firming was warranted

·         The Fed has come a long way, with uncertainty about lagged effects of policy

·         Forward guidance depends on the circumstances. It's helpful when policymakers have a clearer view of things

·         So far, data appear to support the committee's view that lowering inflation will take time

·         Recently, markets have been pricing in a different rate path

·         That seems to reflect a different forecast of inflation coming down more quickly

·         We can afford to look at data and the ongoing outlook

·         Data supports the view that inflation will be slow

·         The market rate path differs from the Fed's forecast

·         The policy is restrictive, and we are concerned about the lag effects of tightening

·         The object is to reach a stance of policy that is sufficiently restrictive, I have not made any decision about how much more firming may be appropriate

·         Fed was expecting further tightening until recently

Overall, Powell sticks with a written script in line with his post-FOMC presser on 3rd May. Although, Powell said policy rates may not rise as much as previously thought because of the banking crisis and credit tightening, Powell didn’t rule out completely a potential +25 bps rate hike in June. Moreover, Powell almost ruled out any possibility of rate cuts in late 2023 as inflation will not fall drastically. But the SWAP market slashed rate hike probability in June and also added to bets for rate cuts by Dec’23 after Powell’s less hawkish comments and as U.S. debt limit talks stalled.

On Friday, while Powell was talking, Republican Debt Negotiator Graves said:

·         The White House is not being reasonable

·         We've decided to press pause on debt ceiling talks because it's just not productive

·         Negotiators all just walked out of the room where debt ceiling talks have been going on

·         Body language is not good

·         Rep. Graves suggested he thinks the WH team is unreasonable

·         We’re not going to sit here and talk to ourselves

·         We're at an impasse

·         Not one issue, but multiple issues have proven problematic

·         There is too much daylight between the sides---A tremendous gap

The House Rep. Speaker McCarthy said:

·         We Can't be spending more money next year

·         The lack of movement by the White House is the reason for the pause

·         Yesterday I felt we had a path to an agreement

·         I have not spoken with Biden

·         We’ve got to get movement from the White House, and we don’t have any movement yet

·         Yesterday, I felt we were at a point where I could see the path

·         We can't be spending more money next year; we have to spend less than we spent the year before. it's pretty easy

·         We’ve got to get movement from the white house and we don’t have any movement yet

The US Senate Republican Leader McConnell tweeted: “Biden waited months before agreeing to negotiate with McCarthy on a spending deal. They are the only two who can reach an agreement. It is past time for the president to get serious. Time is of the essence”.

A White House Official said:

·         Democratic votes will be needed to pass any deal

·         If both sides negotiate in good faith and recognize they won't get everything they want, a deal is still possible

·         Both sides need to recognize they will not get everything they want in a deal

·         Democratic votes will be needed to pass any deal

·         If both sides negotiate in good faith and recognize they won't get everything they want, a deal is still possible

Market wrap:

On Friday, Dow Future tumbled -154 points (-0.46%) while the SPX-500 and NQ-100 futures dropped around -0.30% on lingering political soap opera over U.S. debt limit negotiations. Regional lenders, Western Alliance and PacWest, slid despite adding more than 24% this week. In the corporate news, the stocks of Deere slumped after its earnings and revenue topped forecasts. Shares of Foot Locker plunged following disappointing quarterly results, while Farfetch soared after its first-quarter revenue surprised. On the week, the Dow Jones added 0.7%, the S&P 500 gained 1.8% marking its best week since March and the Nasdaq surged 3%, also the biggest weekly gain in two months.

On Friday, Wall Street was boosted by energy, healthcare, materials, and consumer staples to some extent, while dragged by consumer discretionary, communication services, banks & financials, industrials, utilities, real estate and tech to some extent.


Expect a debt deal by late Sunday/Monday after Biden returns from the G7 meeting. The US has raised the debt ceiling 78 times since 1960 and has never once defaulted while continuing the vicious cycle of huge deficit spending, borrowing, and printing without causing much inflation thanks to China’s cheap export from the 1980s (after China joined WTO). The global reserve currency status of USD is also a great advantage for ‘Uncle Sam’; everyone/country needs USD as it’s the ‘king’ and thus USD is always in demand despite almost 24/7 printing by the Fed; EUR and Chinese Yuan are far behind USD as far global reserve currency status is considered.

The U.S. is now paying around 9.5% of its tax revenue as interest on public debt and can’t afford to increase the same well into double-digit around Japan’s 15%; China and Europe are now paying around 5..5% of revenue as interest on the public debt (deficit spending). Thus the Fed has no option but to pause soon after a possible hike in June but Biden admin also has to reduce elevated inflation by fiscal action.

Apart from monetary action to reduce demand, the U.S. also needs proper/targeted fiscal stimulus/action to increase the supply side of the economy. But such supply-side reform/stimulus needs bipartisan political agreement, whereas present political and policy paralysis is hampering such initiative. Biden admin (Democrats) is now a minority government and has to depend upon the political whims & fancies of opposition Republicans. The same was true when the Republican Trump admin was turned into a minority government after two years of the mid-term election. The U.S. needs some political/legislative reform to allow a stable government to operate for at least 4/5 years (like India) without causing political & policy paralysis year after year.

At the present run rate, U.S. core CPI may take another 6 months; i.e. Sep’23 to fall to around +5.0% and Sep-Dec’24 to further fall around +4.0%, still substantially higher than Fed’s +2.0% targets. Thus Fed needs to keep the real interest rate restrictive /positive enough for a longer period, so that core inflation falls towards +2% targets by Dec’25. Fed may keep the repo rate at 5.50% by June for a real positive U.S. interest rate. Fed should have communicated earlier in a clear way that a real positive interest rate is the basic requirement for ensuring price stability along with supply-side actions by the fiscal authority/government (including peaceful resolution of the Russia-Ukraine/U.S./NATO proxy war).

Fed was already behind the inflation curve from early 2021 when the economy opens fully after the 2020 COVID disruption. Fed should have started to normalize its ultra-loose monetary policy in early 2021 rather than terming higher inflation as transitory and starting the process (telegraphing about QE ending and potential rate hikes) in late 2021. In the process, Fed created synchronized global inflation/stagflation as almost all major G20 central banks usually follow Fed policy action for currency (USD) and bond yield differential. The late action of the Fed coupled with supply chain issues and policy paralysis in the White House created synchronized elevated sticky core inflation globally (except in China).

Fed may go for another +25 bps hike in June for a terminal repo rate of +5.50%, while ECB may further hike by +25 bps each in June and July. Moreover, if core inflation does not dip below +5.00% in the Eurozone by August, then ECB may have no option but to go for a further +25 bps rate hike each in September, October, and December for a terminal repo/MLF rate +5.25%. ECB wasted at least 3 months to match Fed’s rate action and thus now scrambling to match as a consistently weaker EURUSD will also result in higher imported inflation, everything being equal. Europe may be the biggest loser of the Russia-Ukraine/U.S./NATO war/proxy war as it’s an importer of both food and fuel apart from various other commodities. The high cost of living crisis in Europe may invite bigger social and political unrest in the coming days if inflation does not come under control in the coming days.

Fed increased the repo rate by +500 bps in the last year, whereas core inflation was reduced only by -100 bps, in line with a 2Y bond yield increase of about +150 bps. The market is expecting a rate cut by Fed by almost -100 bps by Dec’23 despite Fed trying to pour cold water on that market expectation. The U.S. paid around 9% of its revenue last year as interest on public debt and can’t afford to increase the same well into double-digit around Japan’s 15%; China and Europe are now paying around 5..5% of revenue as interest on the public debt (deficit spending). Thus the U.S. has no option but to pause soon after a possible hike in June but to also reduce elevated inflation by both monetary and fiscal action.

Bottom line:

The market is now almost sure of a debt limit deal by Sunday (21st May) or by next Sunday (28th May)-just before the so-called ‘dooms day’ (30th May). Whatever may be the narrative, technically Dow Future now has to sustain above 33575 for a further rally to 33650/750-850/34375; otherwise sustaining below 33525, Dow Future may again fall to 33150-32950, and sustaining below 32950 may further fall to 32570 (in case of further uncertainty over debt limit).

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