Gold rallied back even as Powell pushed back.
While risk assets slumped on Dec. 14 after the FOMC statement was released at 2 p.m. ET , the dip buyers helped push gold, the S&P 500 and the GDXJ ETF off their intraday lows. However, with Fed Chairman Jerome Powell reiterating his hawkish commitment, the crowd materially underestimates the challenges that lie ahead.
The FOMC statement read:
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/4 to 4-1/2 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”
Thus, while the crowd has been predicting a dovish pivot for months, the FOMC noted that the U.S. federal funds rate (FFR) will seek higher ground in 2023. Therefore, while the crowd is still buying hope and selling reality, higher interest rates are profoundly bearish for risk assets.
In addition, the Fed also released its December Summary of Economic Projections (SEP); and while we warned throughout 2021 and 2022 that the Fed was misjudging inflation, hawkish realities were abound.
Please see below:
Source: U.S. Fed
To explain, the red rectangle above shows that the FOMC increased its median 2023 PCE Index and unemployment rate expectations from September, and reduced its real GDP growth estimate. As a result, the economic outlook continues to deteriorate, and the medium-term implications are highly bearish.
More importantly, the blue box above shows that the FOMC increased its median 2023 FFR estimate from 4.6% in September to 5.1% in December; and while the gold price behaves as if QE is on the horizon, the fundamentals couldn’t be more different.
To that point, Powell said during his press conference:
“I would say it’s our judgment today that we’re not in a sufficiently restrictive policy stance yet, which is why we say that we would expect that ongoing hikes will be appropriate.”
He added:
“There’s an expectation really that the services inflation will not move down so quickly so that we’ll have to stay at it. We may have to raise rates higher to get to where we want to go and that’s really why we’re writing down those high rates and why we’re expecting that they will have to remain high for a time.”
So, while the pivot predictors remain hopeful for a dovish 180, the fundamentals never did, and still don’t, support lower interest rates anytime soon.
Please see below:
Source: CNN
On top of that, we’ve warned repeatedly that bear markets don’t end when the unemployment rate is near a 50-year low; and with the crowd underestimating the demand destruction required to reduce inflation, their expectations are in la-la land. We wrote on Dec. 13 :
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.
Likewise, with Powell reiterating that point on Dec. 14, he understands these historical realities, even if he attempts to keep Americans’ spirits uplifted.
Please see below:
Source: Reuters
Therefore, while the pivot bulls are desperate for a return to pre-pandemic monetary policy, the realities confronting the financial markets in 2023 are much different. Yet, despite their several swings and misses in 2022, the narrative continues to percolate.
Please see below:
Source: Twitter
Moreover, while the ZeroHedge crew assumed the Fed was “done” at 3% and 4%, all of a sudden, now it’s 5%., even though the fundamentals still don’t support that sentiment.
For example, we warned that the FFR has eclipsed the peak year-over-year (YoY) core CPI in every inflation fight since 1961; and since the YoY core CPI peaked (for now) at 6.66% in September 2022, the historically-implied peak FFR is at least 6.67%.
Second, the Atlanta Fed’s Wage Growth Tracker re-accelerated in November, and so did average hourly earnings. Also, the Atlanta Fed’s Sticky Consumer Price Indexes (CPIs) hit new 2022 highs in November, and households’ checkable deposits hit a record high in Q3.
Consequently, the fundamental backdrop is not conducive to 2% inflation anytime soon, and data-driven investors like Hedgeye understand that sentiment does not match reality.
Please see below:
Source: Twitter
Third, we warned on numerous occasions that looser financial conditions are bullish for future inflation. To explain, we wrote on Dec. 14:
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.
To that point, with the dip buyers not getting the memo, financial conditions have decoupled from the FFR and made the Fed’s inflation fight even more difficult.
Please see below:
Source: Bloomberg/ZeroHedge
To explain, the dark red line above tracks the FFR, while the green line above tracks Goldman Sachs U.S. Financial Conditions Index (FCI). For context, both scales are inverted, and falling lines represent a higher FFR and tighter financial conditions.
If you analyze the relationship, you can see that a higher FFR resulted in tighter financial conditions, which meant financial markets aided the Fed in its inflation fight.
In contrast, the green line's rise on the right side of the chart demonstrates how higher stock prices, lower interest rates, a weaker U.S. dollar and smaller credit spreads support inflation and make the Fed's job harder. Again, that's why investors' hopes for a dovish pivot actually reduce the chances of one occurring.
So, the more the markets dissent, the more inflation will reign, and the higher the Fed will need to push the FFR. As a result, don't be surprised if economic reality haunts the pivot bulls in the months ahead.
Overall, the dip buyers are determined to orchestrate a Santa Clause rally, and bullish seasonality aids their case. However, the setup is nearly identical to the summertime, where misguided narratives pushed gold, silver, mining stocks and the S&P 500 higher before they eventually sunk to new 2022 lows. Therefore, we view this bear market rally as no different.
Alex Demolitor
Precious Metals Strategist