With the headline Consumer Price Index (CPI) coming in at 7.1%, the bulls felt like Christmas came early. However, there is a certain "but."
With the headline Consumer Price Index (CPI) coming in at 7.1% year-over-year (YoY) versus 7.3% YoY expected, the bulls felt like Christmas came early. However, we warned before the release :
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.
Thus, with the headline CPI continuing its deceleration on Dec. 13, it was far from unexpected.
Please see below:
But, since oil prices have an outsized influence on the headline CPI, concern has arisen that further weakness in the former could spell trouble for the latter. Yet, please remember that optimism is contagious, and the positivity that uplifts stocks and the gold price filter across other markets.
For example, the USD Index and the U.S. 10-Year real yield declined on Dec. 13, as risk-on currencies and bonds were bid. Therefore, the ‘pivot trade’ was on full display, as a less hawkish Fed is bullish for the euro, Treasury bonds and other risk assets.
Moreover, the recent decline in oil prices was driven by investors’ misguided fears of an imminent recession. In a nutshell: if the global economy is on the brink of collapse, demand for oil should suffer mightily.
Please see below:
Source: Google
To explain, the various headlines above depict the recession sentiment confronting the oil market since late September. As you can see, “recession fears” have been making the rounds, and these fears helped reduce oil prices, which helped reduce the headline CPI. We explained the phenomenon on Dec. 13:
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, with risk assets rising amid the misguided optimism, guess who outperformed on Dec. 13?
Source: Reuters
Consequently, it’s quite humorous how predictable the consensus has become. Remember, when a hawkish Fed creates recession anxiety, asset prices fall, which helps reduce inflation. In contrast, when a dovish Fed (or the perception of one) reduces recession anxiety, asset prices rally, which spurs more inflation. That’s why we wrote investors’ hopes for a dovish pivot actually reduce the chances of one occurring.
So, with the shoe now on the other foot, the mild progress realized when sentiment was depressed is poised to reverse now that sentiment is optimistic.
In addition, the core CPI has already delivered two head fakes since 2021.
Please see below:
To explain, the red line above tracks the YoY percentage change in the core CPI, which excludes the inflationary impact of food and energy. If you analyze the right side of the chart, you can see that the metric declined from June to August 2021 before hitting a new high, and also declined from March to July 2022 before hitting a new high. As a result, the crowd should regret overemphasizing the immaterial progress.
Now, the most important development on Dec. 13 was the behavior of the Sticky CPIs. To explain, we wrote on Nov. 11:
The blue and pink lines above track the YoY percentage changes in the Sticky and core Sticky (excluding food and energy) CPIs. If you analyze the right side of the chart, you can see that both metrics are at their highest levels since 1982.
For context, the Atlanta Fed highlighted the reliability of the Sticky CPI. Researches stated:
“The Sticky CPI is calculated from a subset of goods and services included in the CPI that change price relatively infrequently. Because these goods and services change price relatively infrequently, they are thought to incorporate expectations about future inflation to a greater degree than prices that change on a more frequent basis. One possible explanation for sticky prices could be the costs firms incur when changing price.”
Furthermore, the October 2022 readings of 6.5% and 6.4% match the peaks from September, so while inflation may seem like an old problem, investor sentiment is significantly out of touch with reality.
Therefore, with the headline and core Sticky CPIs hitting new 2022 highs on Dec. 13, broad-based inflation continues to accelerate, not decelerate.
Please see below:
To explain, the November results showed that the headline and core Sticky CPIs hit 6.6% and 6.5% YoY, an increase from the 6.5% and 6.4% YoY realized in October. So, while the crowd celebrated oil prices’ impact on the headline CPI, inflation is much more prevalent; and when the harsh reality shifts sentiment over the medium term, the gold price should confront plenty of downside.
Continuing the theme, data from Hedgeye highlights the crowds’ willingness to buy into uninformed narratives.
Please see below:
To explain, the chart on the right depicts the Sticky CPI results shown above, while the chart on the left represents the cost of goods that are most used by consumers. For context, the basket includes shelter, food at home, medical, energy and wireless services.
If you analyze the red box near the top, you can see that the basket is running at 7.8% YoY; and while market participants believe that inflation will go quietly into the night, the economic data suggests otherwise.
Overall, misguided hope continues to dominate the financial markets and uplift the gold price. Despite the historical lessons learned and the diverging strength of the Sticky CPIs, the crowd doesn’t see the connection between their optimism/pessimism and the movement of inflation. As a result, when the next ‘surprise’ reverses the current optimism, gold’s downside could be immense.
Alex Demolitor
Precious Metals Strategist