Will another inflation miscalculation upend the gold price?
It was only a month ago that investors couldn’t sell bonds fast enough. Now, they’re tripping over one another to get back in. In the process, the positioning shift has weakened the USD Index and helped uplift gold, silver and mining stocks.
Please see below:
To explain, the red line above tracks the USD Index, while the green line above tracks the U.S. 10-Year Treasury yield. More importantly, the black line above tracks the inverted (down means up) December 2023 Eurodollar futures contract.
For context, Eurodollar is a proxy for the expected U.S. federal funds rate (FFR). And since the yield moves inversely to the price, when Eurodollar rises, it means the crowd is pricing in a lower FFR.
Now, if you analyze the relationship, you can see that perceptions of a more hawkish Fed (higher black line) helped uplift the USD Index and the U.S. 10-Year Treasury yield. Conversely, the vertical gray line on the right side shows how the recent banking crisis has the crowd pricing in rate cuts by the end of December (lower black line), which has weighed on the USD Index and the U.S. 10-Year Treasury yield.
However, rate cuts are wishful thinking without a full-blown banking crisis, and a reversal of these expectations should rock the PMs in the months ahead.
For example, while base effects have reduced the year-over-year (YoY) Consumer Price Index (CPI), those benefits run out in a few months. Furthermore, the Atlanta Fed’s Sticky CPIs highlight the embedded nature of inflation.
Please see below:
To explain, the Sticky CPIs remain at cycle highs, despite the deceleration in the headline CPI. Therefore, the Fed has not solved its inflation problem, and investors are too eager for QE to understand the ramifications.
Second, the Atlanta Fed’s Wage Growth Tracker hit 6.1% in February. And if we exclude the highs set during the pandemic, 6.1% would tie the record dating back to 1983.
Please see below:
So, while the crowd assumes that demand destruction has arrived, a recession is imminent and QE is approaching (bullish for the PMs), the fundamentals contrast that narrative. In reality, inflation has not abated, and investors’ attempts to price in a recession intensifies its strength.
Remember, long-term interest rates have declined materially since the banking fears emerged. But, the development is simulative because it lowers mortgage rates and makes financing more affordable. Thus, month-over-month (MoM) inflation should remain elevated until long-term interest rates are restrictive enough.
Please see below:
To explain, the figures above represent the Cleveland Fed’s expectations for various inflation metrics in March and April. If you analyze the CPI and core CPI columns, you can see that the rapid rate rise in February helped keep the MoM CPI relatively subdued at 0.30% – even though it annualizes to 3.66%. Conversely, the April reading has jumped to 0.50% MoM. And while it’s still early in the projection, a realization annualizes to 6.17%.
In addition, notice how the core CPI expectations have barely budged? They have remained in the 0.40% to 0.50% range, and neither support rate cuts anytime soon.
Moreover, while JOLTS job openings came in weaker than expected on Apr. 4, it was far from a surprise due to the 2023 drop in job postings on Indeed. However, the metric has stabilized recently, which signals less pivot optimism in the months ahead.
Please see below:
To explain, the 2023 decline was an ominous sign for JOLTS. But, if you analyze the right side of the chart, you can see that the metric is up slightly over the last three weeks. Therefore, the headlines should be less supportive for bonds and the PMs as we move forward.
Overall, the crowd is attempting to manufacture rate cuts because they’ve grown tired of this inflationary bear market. However, wishing won’t make it come to fruition, and higher stock prices and lower long-term interest rates are the opposite of what’s needed to win this battle.
As such, while sentiment can keep prices decoupled from the fundamentals over the short term, don’t be surprised if panic occurs in the opposite direction in the months ahead.
Do you think a recession is imminent? How does inflation abate alongside lower long-term interest rates? And why aren’t wages falling?
Alex Demolitor
Precious Metals Strategist