Has the narrative changed from ‘sell the rip’ to ‘buy the dip?’
With the S&P 500 selling off at the open and then rallying into the close on Jan. 25, the dip buyers have returned as fear dissipates from the financial markets; and with the Bank of Canada (BoC) aiding their cause with its wait-and-see approach to future interest rate hikes, the crowd sees downside catalysts as few and far between.
For example, the BoC raised its overnight lending rate by 25 basis points on Jan. 25. Its official statement read:
“Inflation is projected to come down significantly this year…. The Bank’s ongoing program of quantitative tightening (QT) is complementing the restrictive stance of the policy rate. If economic developments evolve broadly in line with the MPR outlook, [the] Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases.”
It added:
“[The] Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.”
Also noteworthy, BoC Governor Tiff Macklem was adamant that higher-for-longer interest rates would remain.
Please see below:
So, while the crowd prices in rate cuts later in 2023, please remember that a rise-and-hold outcome is still more hawkish than what’s expected. Therefore, the PMs remain uplifted by a narrative that we view as highly unrealistic.
More importantly, we quoted above how the BoC statement said, “Inflation is projected to come down significantly this year.” Well, do you remember what the BoC said in its Dec. 8, 2021, monetary policy statement?
In contrast, headline inflation did not “ease back towards 2 percent,” and core inflation was not “little changed” throughout 2022.
Please see below:
To explain, the dark and light blue lines above track the year-over-year (YoY) percentage changes in the Canadian headline and core CPIs. If you analyze where the horizontal red line intersects with the light blue line, you can see that the core CPI was at 3.4% YoY when the BoC made those comments in December 2021.
Yet, if you focus your attention on the performance thereafter, you can see that the core CPI ran away from the central bank, which highlights its forecasting fallibility. More importantly, notice how the light blue line has barely budged? The core CPI peaked at 5.5% YoY in July and stood at 5.3% YoY in December.
As a result, while the BoC may believe its inflation fight is over, the central bank is living in fantasy land.
Likewise, if you want to know why the dark blue line has declined, the December inflation report stated:
“The headline CPI grew at a slower pace largely due to slower growth in prices for gasoline…. Consumers paid 13.1% less at the pump in December compared with November, the largest monthly decline since April 2020….. Lower crude oil prices were also reflected in a 14.8% month-over-month (MoM) decline in prices for fuel oil and other fuels.”
So, while we have warned repeatedly that North American central banks’ inflation fights will be arduous, the MoM decline in energy prices drove the headline CPI’s deceleration. Conversely, the core CPI remains well above the BoC’s target, and a 4.5% overnight lending rate is too low to win this inflation battle.
Remember, we follow the fundamentals, not the rhetoric from the Fed or the BoC; and while their statements move markets and impact the gold price, these are short-term phenomena. Furthermore, investors who blindly followed their “transitory” narrative in 2021 suffered mightily. Therefore, we view this as “Transitory Part 2.”
As evidence, China’s reopening has renewed investors’ optimism for economically-sensitive commodities; and surprise, surprise, it's bullish for the headline CPI.
Please see below:
To explain, the Cleveland Fed projected that the January U.S. headline CPI would come in at 0.53% MoM on Jan. 20. Although, on Jan. 25, the estimate was increased to 0.58% MoM. Moreover, while the core CPI has held steady at 0.46% MoM, both annualize to 7.2% and 5.7% YoY, respectively.
Similarly, let’s not forget that the Atlanta Fed’s Sticky CPIs have hit new YoY highs for 17 straight months. As such, just because the Fed or the BoC says something doesn’t mean you should believe it.
Overall, an epic battle is unfolding across the financial markets. The crowd is back to blindly following the Fed and the BoC, leading to lower interest rates and a weaker USD Index. However, like in 2021, we believe they’re all wrong, and history is on our side. Consequently, while the Fed could follow the BoC and lean dovish next week, we expect a much different outcome before it’s all said and done.
Where will the BoC’s overnight lending rate peak? Is 4.5% the end? What tone will Powell strike next week: hawkish or dovish?
Alex Demolitor
Precious Metals Strategist