With the CPI on deck, volatility could be highly elevated.
With the Consumer Price Index (CPI) scheduled for release today, the print will likely swing the pendulum to euphoria or depression. Moreover, with the release on Nov. 10 igniting a violent short squeeze, the S&P 500 rallied sharply on Dec. 12 as the bears wanted to avoid another manifestation.
In contrast, gold, silver and mining stocks declined on Dec. 12, and I’ve warned on numerous occasions that investors overreact to monthly economic data . In a nutshell: one month’s print does not change the medium-term trend, and the Fed’s inflation fight should be one of attrition.
Yet, with oil prices declining in November, they should put downward pressure on the headline CPI; and with investors’ emotional reactions poised to persist, the noise could be amplified. For example, Reuters reported on Dec. 12:
“Pricing in the U.S. options market on Monday implied investors were positioned for the S&P 500 to move 2.5% in either direction in the wake of Tuesday’s consumer price report, which covers November, data from options market-making firm Optiver showed.”
In addition:
“Options prices are projecting a 1.8% swing in either direction for the S&P 500 in the hour immediately following Wednesday's FOMC decision.”
So, with heightened volatility expected on Dec. 13 and 14, the PMs may get caught up in the manic moves. But, with the crowd highly reactive rather than proactive, their reflexivity should be their undoing in the months ahead.
To explain, the crowd believes that lower inflation is a linear process of positive results. However, the pessimism that confronted the financial markets from mid-August to mid-October lowered asset prices and helped calm today’s inflation metrics. Conversely, with that pessimism reversing recently and financial conditions loosening, the current optimism sets the stage for higher inflation over the medium term.
Furthermore, market participants don’t realize that the inflation merry-go-round will spin if they keep overreacting to relatively immaterial progress. In other words: investors’ hopes for a dovish pivot actually reduce the chances of one occurring.
To that point, the Wall Street Journal’s (WSJ) Nick Timiraos – the Fed whisperer – wrote on Dec. 12:
“Some investors think Mr. Powell will flinch on raising rates once unemployment rises, but former Fed governor Randal Quarles, who has known the Fed Chair since they worked in the Treasury Department in the early 1990s, said Mr. Powell is determined to avoid Mr. Burns’s mistakes of failing to control inflation.
“’People really misjudge the fact that Jay is a diplomat and a genuinely good guy to mean he’s a conciliator – which is absolutely not the case,’ said Mr. Quarles, who served at the Fed from 2017 to 2021. ‘He’ll have a very clear view, and he’s committed to doing what the law requires,’ which is to lower inflation.”
Consequently, while the crowd either doesn’t know or doesn’t care about history, the Fed understands the mistakes and embarrassment that occurred in the 1970s.
Please see below:
Source: WSJ
Remember, we warned previously that the crowd is misinformed in its belief that ignoring inflation (a dovish pivot) will solve all of the financial market’s problems. In reality, patience from the Fed will only make a bad situation worse. We wrote on Aug. 9:
Inflation is like termites; it eats away at the U.S. economy until it crumbles. Therefore, the greater risk is not curbing inflation. The [Fed’s Great Inflation] report [stated]:
“Once in the position of having unacceptably high inflation and high unemployment, policymakers faced an unhappy dilemma. Fighting high unemployment would almost certainly drive inflation higher still, while fighting inflation would just as certainly cause unemployment to spike even higher.”
However, with the destructive nature of inflation now obvious (we’re not there yet in 2022), the answer to the “trade-off” was clear, and the narrative shifted dramatically.
Source: U.S. Fed
So, with its own autopsy of the 1970s warning the Fed against a dovish pivot, the U.S. federal funds rate (FFR) should continue its ascent. Furthermore, with the U.S. unemployment rate near a 50-year low, the “unhappy dilemma” from the 1970s hasn’t even started, which means the pivot crowd is buying hope and selling reality.
Likewise, while the headline CPI garners all of the attention, measures of broad-based inflation continue to rise. As a result, the pricing pressures are much more ingrained than the consensus realizes.
Please see below:
To explain, the royal blue line above tracks the year-over-year (YoY) percentage change in the Dallas Fed's Trimmed-mean CPI, while the dark and light blue lines above track the YoY percentage changes in Deutsche Bank's mean and median measures of underlying inflation.
If you analyze the right side of the chart, you can see that the latter two continue to hit new highs. Thus, with broad-based inflation still prevalent, the Fed's issues stretch far beyond supply chains.
On top of that, silver is repeating its bearish pattern from 2012-2013 , where a sharp rally occurred before the white metal fell off a cliff; and with silver's outperformance often an ominous indicator for gold, the technical setup also supports much lower precious metals prices in 2023.
Overall, the crowd's misunderstanding of inflation has them assuming the pricing pressures will ease with little economic damage. But, history contrasts this sentiment, and one can argue that the pandemic-induced imbalances make this bout even worse. As such, pain should confront the believers when reality returns.
Alex Demolitor
Precious Metals Strategist