Nasdaq stumbled on growing US-China tech war; USD surged

On Wednesday, Wall Street stumbled deep into red on hawkish Fed talks and ISM Service PMI data; also S&P PMI survey indicates stagflation risk. But Wall Street Futures also recovered to some extent from the ISM panic low as the Fed’s latest Beige Book survey comes softer than expected. Dow Future tumbled from around 34685 to 34320 but recovered by almost +200 points to close around 34466 (-0.72%).

On Wednesday, Nasdaq-100 lost almost --0.93 % as Apple tumbled after reports that China had ordered officials at central government agencies to not use iPhones and other foreign-branded devices for work. Also, the European Commission designated Amazon, Apple, Alphabet, Meta, Microsoft, and China’s ByteDance as “gatekeepers” under its new Digital Markets Act.

On Thursday, NQ-100 Future came under more pressure on a report China may ban iPhone and certain other foreign mobile brands further for state/local government officials/firms & agencies (apart from central government) amid the growing tech/trade war with the U.S. and also with some countries of Europe/EU (anti-China sentiment). Also, the present policy divergence between China and the U.S. coupled with subdued Chinese economic data is boosting the USD, especially against commodity currencies.

And coupled with subdued economic data from the EU, and U.K. and less hawkish ECB/BOE talks, USD surged to a 6-month high. On Thursday, U.S. Jobless Claims came in lower than expected, while Labor Costs and productivity came in hotter than expected.

Also, hawkish Feds talks, indicating at least another hike in Nov’23 and higher for longer policy coupled with hotter than expected economic data and ‘joker’ (dovish) like comments from ‘Bank of Jokers’ (BOJ) is boosting USDJPY towards 150, while EURUSD tumbled to around 1.06800 and GBPUSD to 1.24500, at multi-months low.

U.S. Initial Jobless Claims Fall to Near 7-Month Low:

On Thursday, some focus was also on U.S. jobless claims (seasonally adjusted), which serves as a proxy for the unemployment trend/overall labor market conditions. The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI-under insurance) decreased to 216K in the week ending 2nd September from 229K in the previous week, below market expectations of 234K and lowest in the last 7-months (since Feb’23).

The 4-week moving average of initial jobless claims, a better indicator to measure underlying data, as it removes week-to-week volatility, also decreased to 229.25K on the week ended 2nd September from 237.75K in the previous week.

The continuing jobless claims in the U.S., which measure unemployed people who have been receiving unemployment benefits for a while/ more than a week or filed for unemployment benefits at least two weeks ago (under UI), decreased to 1679K in the week ending 26th August, from 1719K in the previous week, lower than the market expectations 1715K. The 4-week moving average was 1701.500K, from the previous week's average of 1702.750K. The advance seasonally adjusted insured unemployment rate was 1.1% for the week ending 26th August from 1.2% the previous week. The advance numbers of seasonally adjusted insured unemployed persons were around 1679K for the week against 1719K for the previous week.

The continuing jobless claims of all types are also a proxy for the total number of people receiving payments from state unemployment programs, i.e., the overall trend of unemployed persons (insured). The latest continuing jobless claims are still elevated which may be an indication of some softening in the labor market amid a difficult macroeconomic and geopolitical (external trade) environment coupled with higher borrowing costs and the deluge of tech layoffs (amid generative AI narrative).

Overall, as per seasonally unadjusted continuing jobless claims under all categories (UI) of around 1821K (2-week rolling average) and assuming average uninsured employees/self-employed (not getting any UI benefit) of around 4000K (?), estimated unemployed persons would be around 5821K in Sep’23 against 6355K sequentially. Further, if we assume the labor force is around 168000K, the unemployment rate would be around 3.5% in Sep’23 from 3.8% sequentially. The estimated number of employed persons would be around 161484K in Sep’23, an addition of around +695K sequentially against +222K in Aug’23 (as per Household survey).

On Thursday, Fed’s Williams said:

·         The policy is in a good place and is data-dependent

·         The question before the Fed is does monetary policy needs to become restrictive

·         The Fed has done a lot on monetary policy

·         We are seeing movement in the right direction for the economy

·         Labor market imbalances are evening out

·         Need more data before deciding on the September move

·         Inflation is far too high but moving down

·         There is still more data to come before the next FOMC meeting

·         The housing sector is still seeing strong demand

·         I don't believe the Fed has caused a lasting damage to the housing market

·         Monetary policy takes a year or two to impact the economy

·         Labor market balances are evening out

·         Underlying inflation measures have come down quite a bit

·         Household inflation expectations are well-behaved

·         I expect the unemployment rate to rise to the low 4% range

·         The economy is not seeing a traditional inflation cycle

·         Slowing wage growth points to some success in lowering inflation

·         There are reasons to think consumer spending will moderate

·         The latest consumer spending data has been strong

·         I see a risk of stronger-than-expected growth

·         I expect the unemployment rate to edge up over the next year

·         The open question is whether the policy is restrictive enough

·         Demand in the labor market is coming down

·         The housing market is driven by more than just monetary policy

On Thursday, Fed’s Bostic said:

·         There is still a lot of momentum in the economy

·         The strength of the consumer has kept economic pain at bay

·         I'm unclear on how tension in Chinese real estate resolves

·         The US-China relationship is evolving in a very significant way.

Fed’s influential and ‘right-hand man’ Williams almost confirmed a pause on 20th September, but another hike on 1st November,

Market wrap:

On Thursday, Wall Street, Gold slipped, while USD surged as U.S. Jobless Claims were lower than expected, while Labor Costs and productivity were hotter than expected.  But Dow Future recovered from the jobless claims panic low around 34363 to 34583 before closing around 34542, up around +100 points. But tech-heavy Nasdaq and broader S&P-500 (SPX) slumped on the concern of the Chinese ban on Apple’s iPhone. Chip stocks, such as Nvidia and AMD tumbled. Dow was helped by McDonald’s (analyst upgrade), Intel, Amgen and Walmart (staff pay cut). Wall Street was boosted by Utilities, real estate, consumer discretionary, healthcare, consumer staples, and communication services to some extent, while dragged by techs, materials, industrials, energy and financials.

Conclusion:

The U.S. economy is slowing down, but core service inflation is still quite elevated and sticky; the Fed may hike in November even after a pause in September.

Overall, the YTD (2023) average of underlying core CPI inflation is now around +5.3% and core PCE inflation +4.5%; overall average core inflation (CPI+PCE) is around +4.9% (~5.0%) against the Fed’s current repo rate of +5.50%; i.e., the real repo rate (wrt core inflation) is now around +0.5% (real positive) and at the mid-zone of Fed’s restrictive rate zone (5.00-6.00%).

Although the Fed officially targets core PCE inflation, Fed Chair Powell makes it quite clear that the Fed is now also targeting core CPI inflation to bring it down to +2.0% targets. Also, core service inflation is still quite elevated and sticky, although goods inflation has turned almost negative (deflation). The divergence between core PCE and core CPI inflation continues to be around +1.0% due to differences in constituents and weightage.

In this way, 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 July-September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a 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); now average core inflation (CPI+PCE) is around +5.0% for 2023 (YTD); 6M average core inflation (2023) around +4.95%

Fed may go for a pause on 20th September but may hike another +25 bps on 2nd November, if core inflation does not fall significantly. Fed may go for a long pause to assess the underlying core inflation trend and outlook along with the labor market for July-Sep’23 economic data. Fed may project at least another hike in 2023 in its September dot-plots (SEP) depending upon the actual economic data and outlook. If there is no significant easing of core inflation, especially core service inflation, then the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle.

Fed may now go for a long pause, at least till 1st November’23, to assess the underlying core inflation trend and outlook along with the labor market for July-September ’23 economic data. If core CPI inflation indeed eased further to around +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).

At the current run rate/trend, core CPI inflation should be around +4.0% by Dec’23, +3.0% by June’24, and +2.0% by Dec’24; i.e. at target ahead of the Fed’s estimate of Dec’25. But looking at the overall trend, higher oil prices, and core CPI inflation may also spike again in August-September.

Also, oil prices may stay elevated in the coming months between $75-85 instead of the earlier $65-75 despite US efforts to bring more supply from Iran, and Venezuela (by lessening sanctions) as OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $80 will continue to boost energy/transportation costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $80 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.

In any way, if average U.S. core CPI inflation indeed falls below +4.0% by June’24 (H1CY24) on a sustainable basis, the Fed may go for a +25 bps cut each in July’24 (just ahead of the Nov’24 US Presidential Election) and thereafter every alternate meeting to keep the real repo rate around +1.0% (from 3M/6M average core inflation).

Looking ahead, from March ’24, 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.

Bottom line:

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

Whatever the narrative, technically now, Dow Future (34542) has to sustain above 34200 for any recovery; otherwise 34070/33900-33750/33300 may be on the card.

Similarly, NQ-100 Future (15285) now has to sustain over 15300 levels for any recovery; otherwise 15200/15150-15000/14730 may be on the card.

Gold (XAUUSD-spot-1920) now has to sustain over 1915 for any recovery; otherwise, 1895-1880 may be on the card.

 USDJPY (147.27) now has to sustain over 146.50-148.50 for a further rally to 150.00-152.00; otherwise may correct again to 140.00-137.00 levels in the coming days. BOJ may intervene if USDJPY breaks above 150.00-152.00 red line zones.

EURUSD (1.06900) now has to sustain over 1.06700-300 levels for any recovery towards 1.09870-1.12800 zones; otherwise, 1.05100 may be on the card, which should offer strong positional support (after expected BOJ intervention).

GBPUSD (1.24740) now has to sustain above 1.24600 for any recovery towards 1.27200/800-1.29000/1.31800; otherwise 1.23000-1.22700* may be on the card, which should offer strong positional support.

The market will now watch any real BOJ intervention, Fed talks (ahead of the blackout period), and US core inflation data next week, which should influence the Fed decision in September; unless core CPI does not surge unusually, the Fed is going to pause on 20th September but may hike again for the last time in this hiking cycle on 1st November.