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Wall Street was already under stress Monday on debt deal soap-opera suspense and hawkish Fed talks. On early Tuesday, Dow Future slips from an overnight session high around 33475 after hawkish comments by Fed’s Kashkari and House Majority Leader McCarthy said there is no progress on debt deal negotiations. In the meantime, there was a report that the U.S. Treasury Department has asked federal agencies whether they can make pending payments at a later date, as senior Biden admin officials look for new methods to save money and keep the U.S. government from going into default. As a result, Dow Future slid and made a panic low of around 33180 on the concern of a real U.S. default.
But Dow Future soon recovered almost +200 points, making a high around 34377 after influential hedge fund/investment Blackrock said Fed may pause in June (Blackrock seen as a Fed proxy/mouthpiece). Wall Street was also boosted as debt negotiations between the White House/Biden admin/Democrats and opposition Republicans began. But eventually, Dow Future again stumbled and made another panic low of 33070 after the latest debt deal meeting between the Biden admin and House Republicans ended without any result. Further Fed's Chair Powell arrives at the meeting on Capitol Hill with House Democrats (as earlier announced), but it was clarified that the meeting with the New Democrat Coalition was long-planned, and is not related to the debt-limit deadline.
On late Monday, House Rep. Speaker McCarthy said (after meeting with Biden):
· We don't have a deal
· Nothing has been agreed to in negotiations with Biden on the US debt ceiling
· We can get a deal tonight, or we can get a deal tomorrow
· I think we can make it all happen by the debt deadline (1st June)
· Debt ceiling talks are at a sensitive point
· I believe that the debt ceiling package that is being negotiated now would be acceptable to a majority of house republicans
· We both believe we need to change the trajectory
· Nothing is decided upon, everything is discussed
· Biden and the Democrats want a deal
· I'm not going to waive the 72-hour rule
· Defense cuts are not on the agenda
· I believe we can reach an agreement
· The tone of the conversations tonight was better than usual
· McCarthy on whether Americans should prepare for default: No
· The issue is spending, not revenue
· I am unwilling to discuss revenue increases
· We haven't reached an agreement yet
· I believe we had a productive discussion
· A short-term debt extension would be considered a failure
On late Monday/Tuesday, Republican negotiator McHenry said:
· Sees a “lack of urgency” from the White House
· I'm not sensing urgency from the White House in debt talks
· McHenry on whether he believes June 1 is X-date: “You know, I want to trust the Treasury's math. But they’ve got to show their work. If the president doesn't have a sense of urgency here, then that raises more questions, valid questions, about how they justify the date”
· I can’t say when negotiations will resume
· The top-line disagreement remains on spending
· We still have significant differences in spending
Late Monday, U.S. President Biden said (after meeting with McCarthy)
· I am optimistic we will make some progress on the debt ceiling
· Spending is not the sole solution
· We should look into tax loopholes and ensure that the wealthiest pay their fair amount
· We need a bipartisan accord and the ability to sell it to our constituents
· We need to reduce our spending
· I believe we will make some progress on the debt ceiling
· We reiterated that default is off the table
On Tuesday, GOP Debt Ceiling Negotiator Rep. Graves said:
· Republicans and White House still far apart on debt ceiling deal after Monday night talks
· US debt ceiling talks to resume at 11 am ET (1400 GMT)
· GOP and the White House are still far apart on the debt ceiling deal
· There are some areas where we are very close
· We don't have additional meetings set up
On Tuesday, House Rep. Speaker McCarthy said:
· I told Biden there would be no clean debt limit, no raising taxes, must spend less money
· We are nowhere near a deal yet
· We could still finish this by June 1
· I'm not scheduled to go to the White House today
· We are not there yet
· We had very good discussions and we know where each other is currently located
· No talks are scheduled with Biden yet, staff continuing to talk
· I believe we can still reach a debt ceiling deal before June 1
· We're not putting any debt ceiling plan on the US house floor that doesn't spend less than we spent this year
· I believe we can still reach a debt ceiling deal before June 1
Eventually, on late Tuesday, the White House said:
· Speaker McCarthy has not spoken to President Biden today but had a productive meeting Monday
· We believe there's space for a bipartisan agreement
Late Tuesday, Dow Future recovered around +150 points from the session low of 33070 on hopes of a last-minute debt deal (by 25-28th May) but eventually closed around 33135 as the political soap opera closed for the day. Overall, Republicans are now blaming Biden/Democrats for the imposition of huge taxes on fossil fuel, which is an indirect tax burden for ‘poor Americans. Republicans are also blaming Biden for the EV policy thrust as it will ultimately help China’s EV supply chain. Republicans are also blaming Fed and the White House for the late response to fight inflation by initially terming it as ‘transitory’ and later going for rapid jumbo hikes, resulting in the regional banking crisis.
In brief, Republicans are blaming the Biden admin for economic mismanagement, and political and policy paralysis ahead of Nov’24 Presidential Election. Traditionally Republicans are tax cut and fiscal austerity savvy (conservative), while Democrats are fiscal stimulus savvy (deficit spending) and like to see higher taxes on riches/super riches.
On late Monday/Tuesday, Fed’s Kashkari said:
· It's much too soon to declare all clear on banking issues
· We have a solid job market and are on track to reduce inflation
· US debt estimates are unsustainable
· Rates may have to rise from here
· I don't want to say that we're done hiking interest rates
· We are on a mission to reduce inflation
· There is no way the Fed can protect the economy from the negative effects of default
· The US economy is at risk due to the debt-ceiling issue
· If inflation stays high, we may need to keep rates higher
· A possible mild recession would bring inflation down
· We need to get more data about the economy
On Tuesday, Fed’s Logan said:
· The Fed backstops should be available whenever banks need them, including nights, weekends and holidays
· Banks must regularly test liquidity provisions to make firms and systems more resilient
· The speed of transactions has highlighted the need to manage liquidity risks and every bank should be ready to borrow from the Fed
U.S. Manufacturing PMI Below Forecasts:
Now from politics to economics, on Tuesday, the S&P Global flash data shows U.S. Manufacturing PMI declined to 48.5 in May from 50.2 sequentially, below the market consensus of 50.0. The latest PMI reading pointed to the biggest contraction in the U.S. manufacturing sector in three months and a renewed deterioration in operating conditions. The drop was mainly due to weak demand and a reduced need to hold inputs following improved delivery times and lower new order inflows.
At the same time, output slowed while employment rose the most since September. Increased capacity aided firms’ efforts to process incomplete work. Backlogs fell sharply and at the fastest rate in three years. Meanwhile, input prices fell for the first time since May 2020 and supplier delivery times improved the most on record. Finally, optimism regarding the outlook for output over the coming 12 months was the highest for a year as firms sought to invest in new product development and hoped for an uptick in client demand.
U.S. Service Sector Growth Unexpectedly Accelerates:
On Tuesday, the S&P Global flash data shows U.S. Service PMI increased to 55.1 in May, up from 53.6 sequentially and above market expectations of 52.6. The rate of growth in activity was the fastest for just over a year, with firms linking the upturn to greater demand from new and existing clients. New orders rose at the fastest rate since April 2022 and new export orders grew for the first time in a year, and at a solid rate. Also, the rate of job creation was the fastest for ten months. On the price front, rates of increase in input prices and output charges were faster than their respective series averages. Looking ahead, confidence picked up to the highest in a year amid hopes of sustained increases in client demand.
U.S. Output Growth (Composite PMI) Hits 13-Month High:
Finally, the S&P Global flash data shows U.S. Composite PMI rose to 54.5 in May, up from 53.4 sequentially. The latest reading signaled the fastest pace of expansion in the country's private sector since April’22. The U.S. service sector growth accelerated to a 13-month high helped by stronger demand conditions. Meanwhile, manufacturing production rose only marginally. Total new orders rose for the third month running, despite a 12th consecutive month of decline in exports, and employment levels increased at the fastest pace since July 2022.
On the price front, manufacturers recorded a fall in input prices for the first time in three years while cost burdens at service providers continued to rise markedly. Output charge inflation, on the other hand, remained elevated by historical standards of the survey. Finally, business expectations for the coming year improved in hopes of a pick-up in demand conditions and plans to invest in new products and marketing.
The S&P Global comments about U.S. Composite PMI (May 23):
“The US economic expansion gathered further momentum in May, but an increasing dichotomy is evident. While service sector companies are enjoying a surge in post-pandemic demand, especially for travel and leisure, manufacturers are struggling with over-filled warehouses and a dearth of new orders as spending is diverted from goods to services.
The inflation picture is also changing. Whereas manufacturing prices spiked higher during the pandemic due to strong demand and deteriorating supply, it is now the service sector’s turn to be hiking prices amid resurgent demand and an inability to cope with order inflows due to a lack of capacity. Jobs growth has accelerated as service providers companies seek to meet demand, but this tightening labor market amid strong demand will be a concern as a fuel of further inflationary pressures.”
Overall, the May composite PMI indicated positive GDP growth (despite some manufacturing pain), a tight labor market and elevated/sticky service inflation. The U.S. service sector led by travel & leisure is now witnessing higher demand than supply as the COVID disruption is over and U.S. consumers are still flushed with funds amid upbeat wage growths. Thus Fed has no issue with another one or two rate hikes for a sufficiently restrictive terminal rate (real positive) to bring inflation down toward the target.
On Tuesday, Dow slid above -230 points, while the S&P 500 and the Nasdaq tumbled -1.1% and -1.2% respectively on lack of debt deal progress. Gold surged from around 1954 to 1978, while USD retraced. Among stocks, Zoom, AutoZone and BJ’s Wholesale tumbled amid subdued report cards. But Lowe’s surged after the company beat on earnings. Also, Chevron jumped after the analyst upgrade.
On Tuesday, Wall Street was only boosted by Energy (Chevron) as oil surged on ‘dire warning for short sellers’ by Saudi Energy Minister (ABS). Wall Street was dragged by Materials, Techs, communication services, real estate, industrials, banks & financials, healthcare, consumer discretionary, consumer staples, and utilities.
Expect a last-minute debt deal/breakthrough by the 25-28th after the 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. Putin and Xi will have the last laugh!
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. Putin is winning the financial war against Biden!
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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