Dow, Gold, and bond tumbled on hotter US service PMI in May

·         Nasdaq was supported by Nvidia; Fed may not cut rates even in Dec’24 as goods inflation is resurfacing along with already elevated service inflation

On Wednesday, Wall Street Futures, Gold slumped on hawkish Fed talks and FOMC minutes and fading hopes of Sep’24 rate cut; DJ-30 slumped over -200 points, while tech-heavy NQ-100 lost marginally on hopes & hypes of a blockbuster report card by Nvidia, which came true later. On early Thursday, US/Wall Street Futures recovered to some extent. Dow Future recovered to almost 39881 from Wednesday’s low of around 39700, but stumbled to a low around 39100 Thursday; similarly, NQ-100 future also tumbled from life time high around 19021 to almost 18600 after hotter than expected US PMI report and fading hopes of Fed rate cut even in Dec’24.

On Thursday, the S&P Global flash data shows U.S. Services PMI jumped to 54.8 in May from 51.3 sequentially, well above market expectations of 51.3, and the sharpest expansion in the US private services sector in one year. Inflows of new work rebounded sharply from their slip in April, driving business activity to grow at the fastest pace in over one year, reversing the slowdown in the prior three months despite the continued muted momentum for export demand. Still, service providers opted to shed jobs for the second straight month, with selected firms blaming staff shortages. On the price front, input prices continued to accelerate amid higher staffing costs. Looking ahead, companies reported optimism about output levels in the coming year, but sentiment remained below long-term averages on uncertainty regarding monetary policy and upcoming elections.

On Thursday, the S&P Global flash data shows U.S. manufacturing PMI edged up to 50.9 in May, from 50.0 contraction zone sequentially, and above market expectations of 50.0. The reading signaled an overall modest improvement in private business conditions in the manufacturing sector, as both output and employment made increasingly positive contributions while the drags from new orders and stocks of purchases components moderated. Meanwhile, suppliers’ delivery times quickened marginally on average during the month, indicating less busy suppliers and hence acting as a further minor drag on the PMI. On the price front, manufacturers showed the largest cost rise for one-and-a-half years amid reports of higher supplier prices for a wide variety of inputs, including metals, chemicals, plastics, and timber based products, as well as higher energy and labor costs. Finally, optimism about output in the year ahead also increased.

Finally, the S&P Global flash data shows U.S. Composite PMI surged to 54.4 from 51.3 sequentially, higher than the market consensus of 51.1 and the highest since Apr'22. The service sector drove the upturn with a PMI of 54.8, showcasing the biggest output growth in a year, while manufacturing also saw strong growth with a PMI of 50.9. Despite ongoing job cuts, the pace of employment decline slowed as businesses showed increased confidence in the coming year and saw greater order book intakes. Input costs and output prices rose more quickly, with manufacturing leading the way in price growth in recent months. However, overall selling price inflation remained below the yearly average. Future output expectations also improved from a five-month low in April.

The S&P Global comments about US flash composite PMI for May:

·         The US economic upturn has accelerated again after two months of slower growth, with the early PMI data signaling the fastest expansion for just over two years in May. The data put the US economy back on course for another solid GDP gain in the second quarter (Q2CY24)

·         Not only has output risen in response to renewed order book growth, but business confidence has lifted higher to signal brighter prospects for the year ahead. However, companies remain cautious concerning the economic outlook amid uncertainty over the future path of inflation and interest rates and continue to cite worries over geopolitical instabilities and the presidential election

·         Selling price inflation has meanwhile ticked higher and continues to signal modestly above-target inflation. What’s interesting is that the main inflationary impetus is now coming from manufacturing rather than services, meaning rates of inflation for costs and selling prices are now somewhat elevated by pre-pandemic standards in both sectors to suggest that the final mile down to the Fed’s 2% target still seems elusive

Overall, the S&P Global survey shows the US economy (private sector business activity) is still running hot and goods inflation is again edging up along with already elevated/sticky service inflation. All this means the Fed will take more time to get enough confidence for any rate cut cycle and may not even cut from Dec’24.

On Tuesday (21st May), Fed Governor Waller said in a prepared essay: Little by Little, Progress Seems to be Resuming (At an event at the Peterson Institute for International Economics, Washington, D.C.)

After a run of great data in the latter half of 2023, it seemed that significant progress on inflation would continue and that rate cuts were not far off. However, the first three months of 2024 threw cold water on that outlook, as data on both inflation and economic activity came in much hotter than anticipated.

Initially, it seemed like the bad data might be simply a "bump" in the road, but as the data continued to point in the wrong direction, the narrative quickly turned towards concerns that the economy was not cooling as needed to keep inflation moving down toward the Federal Open Market Committee's (FOMC) 2 percent goal. Progress on inflation appeared to have stalled and there were fears that it might even be accelerating. Suddenly, the public debate became whether monetary policy was restrictive enough and if rate hikes should be back on the table.

But more recent data on the economy indicate that restrictive monetary policy is helping to cool off aggregate demand and the inflation data for April suggests that progress toward 2 percent has likely resumed. Central bankers should never say never, but the data suggests that inflation isn't accelerating, and I believe that further increases in the policy rate are probably unnecessary.

Now let me turn to the data we have seen since the last FOMC meeting. Real gross domestic product (GDP) grew at about a 4 percent annual pace in the second half of 2023, and that stepped down to 1.6 percent in the first quarter of this year. That looked like the kind of moderation that would support progress on inflation, but it was mostly due to two components that tend to be volatile and not reflect fundamental growth—trade in goods and services and additions to inventories.

Private domestic final purchases—which is often a better signal of the underlying strength of demand in the economy—grew 3.1 percent in the first three months of this year, almost exactly the pace in the second half of 2023. I will be watching closely to see whether this measure of economic activity in the first quarter continues in the second. The Blue Chip consensus of private-sector forecasts projects real GDP growth of 2.1 percent this quarter, with only a slight moderation in personal consumption expenditures (PCE) from the first quarter. Others, like the Atlanta Fed's GDPNow model, have a higher forecast.

Nevertheless, there are several reasons why I do expect some moderation in economic activity. One sign of moderation is that retail sales were flat in April and revised down in the previous two months. Retail sales are an important component of consumer spending, so this suggests that consumers may be tempering their purchases. We have also seen credit card and auto loan delinquency rates rise above their pre-pandemic levels, which indicates that some consumer segments are under stress to support their spending levels. That said, services spending data are continuing to look solid and should hold up overall spending in this quarter.

Another sign of moderation in the economy comes from the Institute for Supply Management's (ISM) survey of purchasing managers, those who make spending and investment decisions for businesses. For the first time in four years, the indexes for surveys of both manufacturing and non-manufacturing businesses slipped below 50 in April, indicating that production in these businesses was contracting.

This wasn't surprising for manufacturing businesses, since they have been reporting weakness in employment and inventories for some time. The surprise was that the survey of non-manufacturing businesses, representing the lion's share of U.S. output, fell below 50, indicating a deceleration in activity. This has not happened since December 2022. ISM results can move around from month to month, but if these numbers are sustained, it would be indicative of slowing economic activity beyond manufacturing.

One month does not constitute a trend, but this data suggests that policy is doing its job to moderate aggregate demand, which will support renewed progress in lowering inflation.

Now let me speak about the labor market. The labor market is still relatively strong and supporting a solid pace of job creation, but after progress in bringing demand and supply into better balance in 2023, this rebalancing seemed to stall at the beginning of this year.

Then in the past month or two, the easing of demand, relative to supply seems to have resumed. The hiring rate, reported by the Labor Department, slowed relative to the previous three months. In March, the share of workers who voluntarily quit their jobs declined, with the quits rate falling below pre-pandemic levels. This is a sign that fewer workers are jumping to a new and usually higher-paying job. That means firms are in less need to fill vacancies and offer relatively high starting salaries, something that could support moderating wage increases.

Job creation fell from 315,000 in March to 175,000 in April. A big reason for the decline was a sharp drop in the pace of job creation by state and local governments that is unlikely to be repeated, but private sector job creation also fell, another indication that demand for workers continues to slow. That was also the message I took from the unemployment rate in April, which ticked up to 3.9 percent. It was the 27th consecutive month that unemployment has been below 4 percent, the longest stretch in decades, but it stands noticeably higher than the 3.4 percent rate last April. Meanwhile, the ratio of job vacancies to people looking for work fell to 1.3, just a tenth of a point above the pre-pandemic level and a sign that the relative shortage of workers related to the pandemic is close to over.

Wage growth is still a bit higher than I believe is needed to be consistent with our 2 percent target, but it's not that high, and recent average hourly earnings data suggest that wage growth is moderating. And some measures of wage growth that tend to be forward-looking have also continued to slow on balance.

Just like the data on economic activity, I see the labor market data supporting renewed progress in lowering inflation, so now let me turn to the outlook for inflation.

Last week's report on consumer price index (CPI) inflation in April was a welcome relief after three months without progress toward 2 percent. That said, the progress was so modest that it did not change my view that I will need to see more evidence of moderating inflation before supporting any easing of monetary policy. If I were still a professor and had to assign a grade to this inflation report, it would be a C+—far from failing but not stellar either.

Headline CPI inflation rose 0.31 percent month over month. That barely budged the 12-month total CPI inflation reading to 3.4 percent in April from 3.5 percent in March. More importantly for the inflation outlook, core CPI inflation, which excludes food and energy prices, came in at 0.29 percent, down from 0.36 percent in March, and 12-month core CPI fell to 3.6 percent from 3.8 percent.

Accounting for price data from the report last week on the producer price index, forecasts are predicting both monthly headline and core inflation based on personal consumption expenditures, the FOMC's preferred gauge, which rose a bit less than CPI last month. Most forecasts seem to be in the range of 0.23 to 0.26 percent, which is less than March's monthly increase of 0.32 percent. Although both March and April may round to 0.3 percent, it is good to see monthly inflation falling, even if it requires looking out to the second decimal point.

Looking across these estimates, they suggest that three-month annualized core PCE inflation could decline around 1 percentage point to about 3.4 percent as the outsized January increase rolls off the 3-month average. Like the CPI inflation numbers, this is not where I want to see inflation. But, after having these three-month readings accelerate in January, February, and March, I'm happy to see a reversal of this recent pattern. It leaves me hopeful that progress toward 2 percent inflation is back on track.

Before I say more about the policy implications, this seems like a good moment to make a few points about a bedrock principle of monetary policy—data dependence. The appropriate setting of monetary policy requires understanding how the economy is performing and some idea of where we think it is going. The latter typically means making a forecast or projection, based on standard macroeconomic models, of key variables and what that implies for policy.

But that forecast must be validated by the incoming data. The economy is dynamic, and sometimes new or revised data can significantly change one's understanding of economic conditions and the outlook, which has implications for monetary policy. One data point alone should not change one's view of the economy, and that is why changes in one's outlook and the appropriate path for policy tend to emerge gradually and over time. While you may have confidence in your forecast, incoming data may challenge that confidence. You neither want to overreact to incoming data nor do you want to ignore it.

I am bringing this up because I hear from some quarters the claim that the FOMC has become "overly data dependent." This is a phrase that honestly doesn't make much sense to me but is supposed to mean that we are overreacting to data and allegedly sending confusing messages about the stance of monetary policy.

I don't see how that argument applies to the views of the FOMC if one looks at the Summary of Economic Projections (SEP). Between the March SEP in 2023 and the March 2024 SEP, the Committee median was relatively consistent in projecting around three rate cuts in 2024. This was in the face of some pretty dramatic shocks to the economy. There were bank failures and wider stress in the financial system in the spring of 2023, when it was far from clear what the ultimate effects would be on the economy.

There were significant fluctuations in inflation, which was hot in the first half of last year and then dramatically cooler in the second half. There was the revelation, over time and in different data, that a surge in immigration was augmenting labor supply and allowing a surge in job growth with very little upward pressure on wages and inflation. And then there were geopolitical developments, such as the threat that war in the Middle East might spread to become a wider conflict.

Against this backdrop, the median FOMC participant only gradually reduced their expectation for the unemployment rate at the end of 2024 and essentially left inflation unchanged. Associated with this outlook, the median projection for the appropriate level of the federal funds rate at the end of 2024 moved by at most 50 basis points between the four SEPs over 2024, and more or less held to the median of three 25-basis point rate cuts over the past year.

This hardly seems like an "overly data-dependent" Fed to me. For illustration purposes, contrast that with how the private sector reacted to developments in 2023. The implied federal funds rate based on overnight interest swap quotes for the end of 2024 see-sawed between 2 rate cuts and 10 cuts—for a few days, markets even predicted 11 cuts—and by the end of 2023 ended up implying 6 cuts.

I make this comparison not to denigrate what markets were doing—they were simply revising their forecasts and accompanying risk outlook based on the data to maximize the value of their trading books. My point is that the approach of the FOMC is to set policy appropriately to achieve our dual mandate and typically that requires us to move gradually, extract the signal from noise from the incoming data, and then adjust policy accordingly. Based on the evidence over the past year, I see nothing excessive about our data dependence when projecting the appropriate policy path.

Let me now turn to the implications for monetary policy of my outlook for the U.S. economy. With the labor market as strong as it is; my focus remains on bringing inflation down toward the FOMC's 2 percent goal. The latest CPI data was a reassuring signal that inflation is not accelerating and data on spending and the labor market suggest to me that monetary policy is at an appropriate setting to put downward pressure on inflation.

While the April inflation data represents progress, the amount of progress was small, reflected in the fact that I needed to report the monthly numbers to two decimal places to show progress. The economy now seems to be evolving closer to what the Committee expected. Nevertheless, in the absence of a significant weakening in the labor market, I need to see several more months of good inflation data before I would be comfortable supporting an easing in the stance of monetary policy. What do I mean by good data? What grade do I need to give future inflation reports? I will keep that to myself for now but let's say that I look forward to the day when I don't have to go out two or three decimal places in the monthly inflation data to find the good news.

Fed’s Governor Waller is an influential FOMC policymaker and the market usually takes him seriously. Waller is stressing that although US economic activities, the labor market and also inflation are cooling, it’s not fast enough for the Fed to cut rates. Thus after his comments and hawkish FOMC minutes, the implied probability of a Sep’24 rate cut reduced, while Dec’24 increased; i.e. the market has almost shifted 1st rate cut probability from Sep’24 to Dec’24. In his essay, Waller cited soft April US ISM service PMI data at 49.4 in April from 51.4 sequentially, the 1st contraction of US Service activity since Dec’22 (at 49.2). The US is a service-oriented economy.

But Thursday’s S&P Global flash Service PMI data shows US service PMI jumped to 54.8 in May from an April reading of 51.3. This means that ISM Service PMI for May should also jump around 54.0, well into the expansion zone from the 49.2 contraction zone in April. Waller also acknowledged that the Fed does not consider one month of data for any sudden shift of monetary policy stance; the Fed usually considers at least 3M or 6M rolling average of economic data, especially for core inflation and employment data. Thus it’s now almost certain Fed will modify its dot-plots (SEPs) on 12th June to show one symbolic rate cut (-25 bps) in 2024 (December) or even no rate cuts in 2024, but four rate cuts each QTR in 2025-2026 and two half-yearly rate cuts in 2027 to compensate three rate cuts not done in 2024.

On Thursday, Atlanta Fed’s President Bostic said:

·         The last couple of inflation numbers suggest it's going back to 2%, but going slow

·         The post-pandemic economy may be less sensitive to rates

·         Households and homeowners have locked in low rates, this limits the sensitivity of the economy to Fed policy rate hikes

·         Low-cost debt makes people less sensitive to rate hikes

·         On rates, it is important to move in one direction only

·         The last couple of inflation numbers suggested going back to 2%

·         We may have to be a little more patient and certain about inflation's path to 2% before moving the policy rate

·         Job growth has been robust, which gives me comfort in staying at more restrictive levels

·         We are not in danger of falling into a more contractionary environment

·         We may need to be more patient to avoid heating the economy

·         There is still considerable upward pressure on prices, we're not past the worry point

·         It would not surprise me if it took longer to get to 2% inflation in the US than elsewhere

Conclusions: Fed may not cut even in Dec’24 and may revise June dot-plots

Overall, the Fed is now changing its tone and gradually preparing the market for no rate cuts in 2024, especially from Sep’24 to avoid any political controversy just ahead of Nov’24 US election.

The 6M rolling average of the US unemployment rate is now around +3.8%, while core CPI inflation is around +3.9%; i.e. US core CPI inflation is still substantially above the Fed’s +2.0% targets, while unemployment rate is still below the Fed’s 4.0% red line. Thus theoretically, the Fed has still space for a higher longer policy stance (restrictive) to produce additional slack in the economy, so that underlying demand decreases further to some extent to match the present supply capacity of the economy, bringing inflation down towards +2.0% targets on a sustainable basis. Fed now needs more confidence for the disinflation process, which is now almost stalled after a good pace in H2CY23.

Also, looking ahead, the Fed may keep B/S size around $6.60-6.50T, around pre-COVID levels and 22% of estimated CY26 nominal GDP around $30T to ensure financial/Wall Street stability along with Main Street stability; i.e. price and employment stability. Fed’s B/S size should be around $7.30T by May’24. At around the projected QT tapering rate of $0.04T/M, it may take 18 months from June’24 to reach the targeted Fed B/S size of around $6.60T; i.e. by Dec’25, Fed’s QT may end with the B/S size around $6.60-6.50T.

Rate cuts along with QT (even with a slower pace/tapering) should be less hawkish:

Ahead of the Nov’23 U.S. Presidential election, White House/Biden/Fed/Powell is more concerned about elevated inflation rather than the labor market; prices of essential goods & services are still significantly higher (around +20%) than pre-COVID levels, which is creating some anti-incumbency wave (dissatisfaction) among the general public (voters) against Biden admin (Democrats) amid higher cost of living.

Thus Fed is now giving more priority to price stability than employment (which is still hovering below the 4% red line) and is not ready to cut rates early as it may again cause higher inflation just ahead of the November election. Fed may have cut only from Septenber’24, which will ensure no inflation spike just ahead of the Nov’24 election (as any rate action usually takes 6-12 months to transmit in the real economy, while boosting up both Wall Street and also Main Street (investors/traders/voters). Fed hiked rate last on 26th July’23 and may continue to be on hold till at least July’24; i.e. around 12 months for full/proper transmission of its +5.25% cumulative rate hikes effect into the real economy.

Overall, the Fed’s mandate is to ensure price stability (2% core inflation), and maximum employment (below 4% unemployment rate) along with financial/Wall Street stability as well as lower borrowing costs for the government. As the US is now paying almost 15% of its tax revenue as interest on debt, the Fed will now not allow the 10Y US bond yield above 5.00% at any cost (against present levels of average core CPI around +4.0%).

But the Fed may also blink on rate cuts in H2CY24 just before the US election to avoid any political controversy:

Ahead of Nov’24 US Presidential election, as seen in the Mar’24 Congressional testimony, Fed/Powell is under huge pressure from opposition Republican lawmakers (Trump & Co) to support Biden & Co (Democrats) in boosting the election prospect by facilitating rate cuts just before the Nov’24 election. Thus Fed may not go for any rate cuts till Nov’24 or even Dec’24 to show that it’s politically independent/neutral.

The most logical step would be Fed to close the QT completely before going for a rate cuts cycle and then go for any QE, if required to counter another economic crisis down the years. Fed has to prepare its B/S for the next round of QQE to face another cycle of financial crisis and thus has to normalize the B/S first. Presently, it seems that the Fed is not so confident about the original QT pace, around 0.07T/M which may trigger another QT tantrum, as we have seen in late 2019.

Fed is ‘extremely’ worried about the pace of slower disinflation. Fed is also apparently confused about the dual combination of QT, even at a slower pace (QT taper) and rate cuts in the months ahead as these two instruments (tools) are contradictory/opposite (like if the Fed goes for QE and rate hikes at the same time). Ideally, the Fed should finish the QT first for a proper B/S size (bank reserve) to ensure ample liquidity for the US funding/money/REPO market.

But the Fed may continue QT (even at a slower pace) and go for a rate cut cycle at the same time despite these two policy actions being contradictory. Bank of Canada (BOC), recently clarified as long as the policy rate remains within the sufficiently restrictive zone, BOC may go for limited rate cuts, along with QT (even at a reduced pace) as QT is itself equivalent to rate hikes to some extent (tighter banking/funding/money market liquidity). If the real policy rate falls into the stimulative zone amid a fall in inflation, then the BOC may go for more rate cuts and completely close or at least temporarily close the QT. BOC is the smaller proxy of the Fed and may have more academic clarity regarding its policy actions.

Thus the Fed may go for rate cuts of -75 bps cumulatively in September, November, and December’24 for +4.75% repo rates from the present +5.50%. But after recent remarks by various Fed policymakers, it seems that the Fed may not cut thrice in 2024 from Sep’24 and may cut only once (symbolic) in Dec’24 or may not cut at all in 2024.

The market is now expecting 3 to 1 rate cuts (75-50 bps) in 2024, while some Fed policymakers are now arguing for lesser rate cuts of 1-2 rate cuts or even no rate cuts at all. Looking ahead, the Fed may not cut rates at all in 2024 considering the slower rate of disinflation, political issues ahead of the Nov’24 election, and the logic that it should not go for any rate cuts while doing QT, which is the opposite. Also, the reduction of B/S from around $8.97T to around $6.60T (projected); i.e. around $2.50T (~$2.37T) reduction over 2.5-3.00 years is equivalent to a rate hike of around +50 bps (higher 2Y bond yield).

In that scenario, if the US core CPI average for 2024 comes down to around +3.00% by Dec’24 from present levels of +3.8%, the Fed may cut rates by -100 bps in 2025 for a repo rate +4.50% (from present +5.50%) for a real restrictive repo rate +1.50% (repo rate 4.50%-3.00% projected average core spi for 2024). Presently, the real restrictive repo rate is also around +2.00% (repo rate 5.50%-3.50% average 6M core inflation).

At present, in its last (Mar’24) SEP/dot-plots, the Fed projected -75 bps rate cuts each in 2024, 2025, and 2026 and -50 bps rate cuts in 2027 for a terminal neutral repo rate +2.75% against pre-COVID neutral repo rate +2.50%. Now various Fed policymakers are arguing for a slightly higher neutral repo rate at +3.00% against projected core CPI of +2.00%; i.e. neutral real rate at +1.00%.

Thus depending upon the actual trajectory of core CPI, the Fed may cut -100 bps each in 2025, 2026, and -50 bps in 2027 for a terminal neutral repo rate of +3.00% from the present +5.50%. Fed had boosted its B/S from around $3.86T in late September’2019 (after the QT tantrum) to around $8.97T in Apr’22; i.e. over $5T in a matter of 32 months (@0.16T/M) to fight previous QT and COVID induced financial crisis.

Although, the Fed’s official QT rate is -$0.095T/M ($90B/M), in reality, the effective average QT rate is already around -$0.073T/M. As the Fed is now managing the funding/money market through ON/RRP, there is a lower risk of a 2019 type of QT tantrum this time.

Fed’s mandate is now 2% price stability (core inflation), below 4% unemployment rate, and below 4.75-5.00% US 10Y bond yield to ensure lower borrowing costs for the government and overall financial stability. Fed, as well as ECB, BOE, and BOC, are now struggling to keep bond yield and inflation at their preferred range despite non-stop jawboning; perhaps they are talking too much too early and thus FX market is not being influenced by them significantly, moving in a narrow range. The BOJ is now trying to talk down the USDJPY desperately, presently hovering around 152 levels, causing higher imported inflation and a higher cost of living back home, although it may be beneficial for exports. However, most of the Japanese are not happy at all due to higher imported inflation in Japan for the devalued currency.

The 6M rolling average of US core inflation (PCE+CPI) is now around +3.5%. Fed may start cutting rates 75 if the 6M rolling average of core inflation (PCE+CPI) indeed eased further to +3.0% by CY24. The Fed wants to keep the real/neutral rate around +1.0% in the longer term (assuming a +3.0% repo rate and +2.0% core inflation). But in the meantime, till core inflation/headline inflation goes down to around 2.00%  on a sustainable basis, the Fed wants to maintain the real rate at around present restrictive levels of 1.00-2.00% (assuming the present repo rate 5.50% and 2023 average core inflation around 4.50% and present 6M rolling average of core inflation around 3.50%). Fed needs a +2.00% restrictive real rate for 2024 or at least H1CY24 to produce sufficient slack in the economy, so that core inflation falls to +2.0% target on a sustainable basis.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C-D)*(E-B)

=1.50+2.00+ (2.60-2.00)*(4.50.00-2.00) =1.00+2+ (0.60*2.50) = 3.00+1.50=4.50% (By Dec’24)

Here:

A=desired real interest rate=1.50; B= inflation target =2.00; C= Actual real GDP growth rate for CY23=2.6; D= Real GDP growth rate target/potential=2.00; E= average core (CPI+PCE) inflation for CY23=4.50%

Less likely: 1st scenario: 75 bps rate cuts each in 2024, 2025, 2026, and -50 bps in 2027 for a neutral repo rate of +2.75%; More likely 2nd scenario: -100 bps rate cuts each in 2025, 2026, and -50 bps in 2027 for terminal neutral reo rate +3.00%

Fed will continue the QT at a reduced rate of around 40B/M till Dec’25 for a B/S size of around $6.60-6.50T. Fed may continue the QT (even at an officially slower pace) and rate cuts at the same time despite being contradictory. Fed may say (like BOC) that as long as the policy rate is in the restrictive zone (say 1.50-2.00% above core inflation), the Fed may continue both rate cuts and QT to reduce overall restrictiveness. When the policy rate moves into a neutral/stimulative zone, say 50 bps above average core inflation, then the Fed may go for more rate cuts and close the QT.

All other major G20 Central Banks including ECB, BOE, BOC, RBI, and even PBOC may be compelled to follow the Fed’s real rate action to keep present policy differential with the Fed. As USD, is the primary global reserve/trade currency, any meaningful negative divergence with the Fed will result in higher imported inflation, everything being equal; for example, if the ECB goes for -75 bps rate cuts in H2CY24, while the Fed goes for hold, then EURUSD may slip further towards parity (1.0000), which will result in higher imported inflation as the EU is dependent quite heavily on imported goods, foods, and fuel/commodities.

In this way, no major G20 Central Bank will take such rate action/cuts alone as there is a routine/regular coordination/consultation between all major central banks for a coordinated/synchronized policy action to avoid disorderly FX movement. The Fed also not seeking a very strong USD as it would eventually affect US export competitiveness. Thus all major central banks are now focusing on maintaining proper balance and coordination with the Fed, whatever may be the domestic inflation/economic narrative/jawboning.

Market impact:

On Thursday, Wall Street Futures plunged on fading hopes of a Fed rate cut from Dec’24 after hotter than expected S&P Global Service PMI data for May, well into the expansion zone after a brief dip around the contraction zone in April. Blue chip DJ-30 tumbled over -600 points, sharpest single day slide in 2024 (till day); broader SPX-500 inched down -0.7%. while tech-heavy NQ-100 edged down 0.4%. Nasdaq was supported by an upbeat report card from Nvidia, while Dow Jones (DJ-30) was dragged by index heavyweight Boeing after its CFO projected negative FCF (Free Cash Flow) in Q2CY24 amid no recovery in aircraft deliveries due to ongoing slow production issues.

On Thursday, Wall Street was dragged by real estate, utilities, consumer discretionary, banks & financials, industrials, consumer staples, communication services, healthcare, energy, and materials, while boosted by techs. Script-wise, Wall Street was dragged by Boeing, Intel, Apple, McDonald’s, J&J, Walt Disney, Travelers, IBM, Amazon and Chevron; all 30 blue chips in DJ-30 were in deep to moderate red.

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

Whatever may be the narrative, technically Dow Future (40132) has to sustain over 40400 for a further rally to 40500/40600-40700/41000 and even 42000-42700 in the coming days; otherwise, sustaining below 40350-40200 DJ-30 may again fall to 39900*-39700/39200-38900/38500 and 39100*/37400 in the coming days.

Similarly, NQ-100 Future (18750) has to sustain over 19100 for a further rally to 19200-19450/19775 and 20000/20200 in the coming days; otherwise, sustaining below 19050/19000 may fall to 18850-18750, may again fall to 18350/18100-18000/17900 and 17800/17700-17600-17500 and further 17400/17300-17100/17000* in the coming days.

Technically, SPX-500 (5330), now has to sustain over 5400-5450* for any further rally in the coming days; otherwise, sustaining below 5375 may fall to 5275/5175-5100/4990 and 4950/4900*-4850/4825 and 4745/4670-4595/4400* in the coming days.

Also, technically Gold (XAU/USD: 2415) has to sustain over 2455 for a further rally to 2475/2500; otherwise sustaining below 2450/2440-2435/2430, may again fall to 2398/2372-2350*/2335 and 2310/2300-2290/2370 in the coming days.

Technically Oil (78.30) now has to sustain over 76.50-75.00 for any recovery to 78.50/80.50-82.00/85.00-88.00-90.00/91.00-95.00; otherwise sustaining below 74.50, oil may further fall to 73.00 and 72.00-70.00 in the coming days.