Wall Street surged on tech and debt deal progress boost

Wall Street Futures surged Wednesday on rising optimism about the debt ceiling deal and renewed optimism about regional banks (after Western Alliance reported deposit growth). But late Wednesday, Dow Future also slips -100 points from around 33540 on the renewed concern of further political soap opera over debt limit after a report that some Senate Democrats urge Biden to prepare to invoke the 14th Amendment to tackle the debt limit issue. In any way, Gold was under stress on the progress of U.S. debt limit talks; USD gained.

On Thursday, Fed’s Logan said:

·         The evidence in the upcoming weeks may still demonstrate that skipping a meeting is acceptable. Yet, as of right now, we haven't arrived

·         Current data doesn’t justify pausing rate hikes yet

·         Data at this time do not support delaying rate increases

·         Data at this time does not support skipping a rate hike at the next meeting in June

·         Data incoming weeks could yet show that it is appropriate to skip a meeting

·         As of today, we are not there yet

·         The Fed still has work to do in achieving its goal of price stability

·         It is a long way from here to 2% inflation

·         The core PCE price index ran a 4.9% annualized pace in the 1st quarter. That was higher than the 4.4% pace in the 4th quarter of 2022

·         Keeping an open mind ahead of the June meeting

·         I am concerned about whether inflation is falling fast enough

·         Fed has not made enough progress toward the 2% target

·         Inflation is much too hard

·         Restoring price stability is a critical priority

·         The labor market has called an economy that is less out of bounds

·         Recognizes arguments against tightening policy too much or too fast

·         The effect of banking stress affects so far is comparable to a 25 – 50 basis point Fed policy rate increase

·         Every bank in the US it should be fully set up at Fed's discount window and run regular tests

 On Thursday, Fed’s Jefferson said:

·         Monetary policy should be forward-looking

·         The evidence so far points to only a modest incremental tightening of credit conditions due to recent bank stress

·         Core services inflation excluding housing is stubbornly high

·         Demand has begun to feel the effect of hikes

·         1 year isn't long enough to feel the policy's effects

·         Inflation is too high and progress has been slowing

·         I intend to consider uncertainty about tighter lending

·         It is hard to say how much bank stress will curb credit

·         inflation is too high and by some measures, progress is slowing, but a year is not long enough to feel the full effect of interest rate hikes so far

·         The outlook is not for recession, but growth has slowed considerably

·         Expect job growth to also decline and the unemployment rate may rise

·         The evidence so far points to only a modest incremental tightening of credit conditions to recent bank stress

·         Remains uncertain how tighter credit will influence household and business spending

·         Inflation in non-housing services has shown no signs of a significant decline

·         Will consider all these factors in deciding the appropriate stance on monetary policy for the June meeting

·         History shows that monetary policy works with long and variable lags and that a year is not a long enough period for demand to feel the full effect of higher interest rates

On Thursday, Fed’s Barr said:

·         The Fed weighing stricter liquidity rules after SVB

·         There is no inherent conflict between monetary policy, supervision by the Fed

On Thursday, Fed’s Bullard said:

·         What is likely to affect the economy more significantly is a recent decline in yields on treasury bonds

·         I do expect disinflation

·         I support lifting interest rates further as an insurance policy against inflation

·         Favors one more 25 bps hike in June, but I am open-minded

·         I do not expect disinflation, but it's been slower than I would have liked, and it may warrant taking out some insurance by raising rates somewhat more to ensure that we do get inflation under control

·         I would stay open-minded going into June since the current rate is at the lower range of sufficiently restrictive levels

·         Still believes rates are at the low end of sufficiently restrictive with the top and seen just above 6%

·         Probably be better and more prudent to be in the middle of the zone 5.00-6.00% (i.e. ~ 5.5%)

·         I do expect disinflation, but it’s been slower than I would have liked, and it may warrant taking out some insurance by raising rates somewhat more to make sure that we do get inflation under control

·         Our main risk is that inflation doesn’t go down or even turns around and goes higher, as it did in the 1970s

·         Concerns about the impact of banking stress were overemphasized

·         We’re trying to have this disinflationary pressure and that’s supposed to come through higher rates

·         It’s a bit concerning that yields are going in the wrong direction

·         Maybe this will fuel a slower disinflation or even a little bit more inflation going forward than what we intend

·         The labour market is also not just strong, it’s very strong

·         A potential debt default is equivalent to shooting ourselves in the foot because it will probably lead to a spike in US borrowing costs

On Thursday, the U.S. House Speaker/Majority Leader McCarthy (Republican) said:

·         The House must vote next week to meet the default deadline

·         We are at a much better place than a week earlier

·         I can see now where a deal can come together

·         We are negotiating the scope of the spending cut and debt ceiling lift

·         Thinks an eventual debt bill needs to be on the floor next week

·         We are not there. I see a path

·         I just believe where we were a week ago and where we are today is a much better place because we've got the right people in the room discussing it in a very professional manner with all the knowledge and all the background from all different leaders and what they want

Market impact:

On early European Thursday, Dow Future recovered from around 33415 to almost 33540 on positive cues from the European market amid better-than-expected GDP and softer-than-expected core inflation data, which may keep ECB on a small calibrated rate hike @+25 bps for the next few months. Wall Street Futures were also boosted by the progress of the U.S. debt limit deal and renewed faith in regional banks.

In the early Thursday U.S. session, after a brief retracement, Dow Future jumped further and made a high of around 33555 from 33475 on Wall Mart and Target boost (earnings and guidance beat). But Dow Future soon stumbled over -200 points and made a low around 33335 on hawkish talks by Fed’s Logan and better-than-expected jobless claims data.

But Dow Future again recovered over +200 points and jumped to almost 33564 on hopes of further progress in U.S. debt limit talks after House Majority Leader McCarthy said talks are moving forward and by early next week, Congress should pass any debt limit deal bill to avoid a default, as a debt-ceiling agreement by Sunday is doable.

Again, Dow Future stumbled and made a panic low of around 33280 after Fed’s Bullard indicated another rate hike in June as an ‘insurance’ against inflation. Again, in another day of volatile trading, Dow Future recovered, made a high around 33651 before closing around 33600 on debt limit deal optimism after Senate Majority Leader (Democrat) Schumer said talks are moving satisfactorily and Senators should be ready to come to Capitol Hill (Washington) in a short notice (24-hrs). Late Thursday, U.S. Treasury Secretary Yellen reaffirmed the strength of the US banking system in the meeting with bank CEOs and discussed the urgent need for Congress to address the debt limit.

The risk sentiment was also boosted by a report by WSJ’s influential Fed watcher Timiraos that the Fed is planning B (backup plan) in the event of no debt deal on time (in an unlikely scenario).

WSJ’s points for potential actions from the Fed and some comments:

·         Buying Treasury’s shunned by investors due to delayed payment risk or allowing banks to pledge defaulted securities as collateral for loans from the central bank (Fed)

·         In 2011 the Fed plan involved managing government payments to prioritize principal and interest on government debt, allowing banks to count defaulted treasuries toward their required capital buffers, and not penalizing banks facing a drop in capital ratios due to unusual cash demands

·         Although some contingency strategies exist, the Fed's ability to remove defaulted securities from the market is limited given the size of the Treasury market

·         Once again, it is probably not the odds-on favorite for a debt ceiling plan not passing, but, if an agreement is delayed and it forces a shutdown (it is likely to be temporary), it is best to know what can be done

·         Regardless, however, the rating agencies would likely downgrade US debt, which could force rates higher (at least in the short term) and likely lead to increased risk in other markets including stocks

Market wrap:

On Thursday, all three major US indexes finished in the positive territory, extending a rally from the previous session. The blue-chip Dow finished more than 110 points higher (after a volatile day of trading), and S&P 500 and the Nasdaq added 0.9% and 1.5% respectively, as the market digested the latest corporate results and the debt ceiling negotiations. Netflix jumped after the streaming company said it had 5 million monthly active users for its cheaper, ad-supported option. Synopsys soared following upbeat revenue and earnings while Nvidia jumped as it announced it joined ServiceNow to build AI for enterprises. Also, Walmart surged after the retailer raised its full-year forecast, and earnings topped expectations.

On Thursday, Wall Street was boosted by techs, communication services, consumer discretionary, banks & financials, industrials, materials, and energy, while dragged by real estate, consumer staples, utilities, and healthcare. Nasdaq-100 hits 12-month high, Apple hits 39-week high, AT&T hits 16-week high, S&P-500, FB/Meta hits 15-week high.

Conclusion:

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).