Oil, Dow tumbled US debt deal passage suspense; Gold surged

Wall Street Futures stumbled Monday in a holiday-thinned trade despite a provisional US debt deal as the market is now concerned about the actual passage of the deal in Congress amid political compulsion of both Democrats and Republicans for supporting the debt/budget deal in its present form.  On early European Tuesday, USD surged and Gold, Oil slumped to around 1932 and 71, but soon USD stumbled (after the Japanese jawboned about lower levels of Yen) and Gold, Oil and also Wall Street Futures recovered to some extent.

Further on Tuesday, although Dow Future surged briefly by almost +100 points early European session on debt deal and AI optimism. Nvidia tops the trillion-dollar market cap after introducing an AI supercomputer. Nvidia introduces an AI supercomputer to create ChatGPT successors. The company behind the world’s most powerful chip for developing AI tools revealed more AI-powered products, including an AI chip.

But Dow Future again stumbled early U.S. session after the start of political bytes of various lawmakers of both Democrats and Republicans for/against the debt/budget deal. The market is now concerned about the passage of the debt deal in the US Congress after several Republicans have stated that they will not vote in favor of it:

·         Democratic Rep. Boyle: Enough Democrats will support the debt-limit deal

·         GOP Rep. Mace: I am voting no on the debt ceiling deal

·         Republican Rep. Norman: I will vote against the debt ceiling bill in the committee if it is not amended

·         GOP Rep. Roy: There is going to be a reckoning over the debt limit deal

·         Freedom Caucus Chairman Perry: The debt deal fails to deliver

·         Republican Rep. McHenry: I do not doubt that the debt ceiling bill will pass the house

·         Republican Rep. McHenry: More than half of the House Republicans will support the debt ceiling bill

·         House Rep. Speaker McCarthy: The debt ceiling bill is easy for Republicans to vote for

·         House Freedom Caucus leaves open the possibility of filing a motion to vacate the chair if Speaker McCarthy pushes through the debt deal

·         House Rep. Speaker McCarthy: I'm confident of getting adequate Republican support for the debt ceiling bill on the house rules committee

·         US House Democratic Leader Jeffries: I expect Republicans to keep a promise of at least 150 Republican votes for the debt limit bill

·         US House Democratic Leader Jeffries: I do not see a problem winning the House Rules Committee advancement of debt limit bill

·         US Senate Majority Leader Schumer: The Senate will vote on the debt deal as soon as possible

·         White House Budget Director: There is no indication that X-date for the debt ceiling may slip back

·         White House: President Biden is having conversations with both progressives and moderates

·         White House: President Biden has been talking to Democratic members of Congress on the debt ceiling

·         US Republican Rep Massie: I anticipate voting for the bill suspending the debt ceiling in the House Rules Committee

On Tuesday, Fed’s Barkin said:

·         Bank loan volumes have held up pretty nicely, even as banks get more selective

·         Inflation is going to be more stubborn than many people would hope

·         I am hearing less about the risk of wage increases

·         There is more willingness among businesses to try to increase prices, and that will continue until demand falls

·         Some parts of the economy appear to be cooling, others remain vibrant

·         However the components are analyzed, it still seems inflation is too high

·         It would be shocking if, in a future recession, rates did fall again to zero

·         There is uncertainty around where rates need to go

·         It is hard to count on rate hikes to do all the work on inflation

·         I am looking for signs that demand is falling

·         Fed policy is in restrictive territory, but there is uncertainty about where rates need to go

·         The hope is that rates can stay at a neutral and normal level for some time and that would be healthy for the economy

Market wrap:

On early Tuesday, Dow Future made a panic low of around 33921 from an earlier session high of 33238 amid debt limit passage political suspense. But Dow Future also recovered over +200 points to close around 33100 in hopes of an imminent passage of the debt/budget deal after the House Rules Committee starts the Debate on the Debt Ceiling. But Nasdaq was relatively stable amid Nvidia/AI optimism; now surged over +25% YTD. Among tech shares, Netflix, Intel and Qualcomm jumped. Tesla soared after CEO Musk told Chinese Foreign Minister Gang that he is willing to expand business in the country. On Tuesday, Wall Street was dragged by consumer staples, energy, healthcare, materials, utilities, industrials and communication services to some extent, while boosted by techs, consumer discretionary and real estate.

Oil tumbled on debt/budget deal passage suspense and the concern of lower demand from China amid a deluge of soft economic data recently. Meanwhile, doubts persist on whether OPEC+ will cut production during a meeting on June 4 after Saudi Arabia Energy Minister Prince Abdulaziz bin Salman (ABS) warned short sellers to ‘watch out’ for potential consequences last week. In contrast, Russian Deputy Prime Minister Novak stated that he anticipated no new measures from OPEC+ as the group just implemented production cuts this month.

Oil also slips after a report that IEA is taking a softer stance on Iran. On Tuesday, the Secretary General of OPEC+ Ghais said OPEC will welcome the return of Iran to the international oil market once the U.S. lifts sanctions from Tehran: "We believe that Iran is a responsible player amongst its family members, the countries in the OPEC group. I’m sure there will be good work together, in synchronization, to ensure that the market will remain balanced as OPEC has continued to do over the past many years.”

Biden admin may lift Iran sanctions in the coming days to deal with Russia-Saudi OPEC+ cartel to ensure the lower price of oil ahead of Nov’24 U.S. Presidential election and Russia’s energy/oil blackmail strategy amid the lingering Ukraine war. Meanwhile, Iran and Saudi Arabia have been working to restore their diplomatic relations with the help of mediation from China. The two earlier this year agreed to reopen their respective embassies and forge closer economic ties. The gasoline demand was also softer in the U.S. Memorial holiday driving weekend amid higher cost of living.

Conclusion:

Expect a last-minute debt deal passage after the political war of attrition gets over in line with respective political compulsions. Both Democrats and Republicans would be squarely blamed if there is any real U.S. debt default and subsequent chaos in the financial market. 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 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:

Fed may hike +0.25 bps in June for a terminal repo rate of +5.50% and go for pause (not pivot) in July and September to assess the impact of higher rates on inflation and the labor market; if core inflation still doesn’t drop substantially, then Fed has no option but to go for another +25 bps hike in November and December for a terminal repo rate +6.00%.