What investors think is a big deal is actually no deal at all.
The hype train has arrived, and investors are eager to ride the narrative as long as they can; and with gold’s 2023 strength driven by false hopes for a dovish pivot, the chorus could grow louder on Jan. 12.
For example, the U.S. Bureau of Labor Statistics (BLS) will release the Consumer Price Index (CPI). Moreover, with the crowd assuming that the long-term issues can be resolved with one print, they’re using hyperbole to justify their lack of historical knowledge about inflation.
Please see below:
Source: ZeroHedge
So, while the narrative proclaims that this CPI print is significant, the reality is that the small declines in recent months have no bearing on the medium-term ramifications. For example, the decline in oil prices has driven the headline CPI’s weakness, even as core inflation remains uplifted. To explain, we wrote on Dec. 14:
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
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.
To that point, with the crude oil price suffering in recent months, the headline CPI’s deceleration was far from unexpected.
Please see below:
To explain, the candlesticks above track the performance of the crude oil price since November. The data shows that crude futures have struggled recently, which supports lower headline inflation and fuels the bulls’ misguided optimism.
But, the crowd misses the forest through the trees. With core inflation – which excludes food and energy – still resilient, normalizing the metric to 2% should be much more challenging than the consensus realizes.
As evidence, Eurozone headline inflation declined from 10.1% YoY in November to 9.2% YoY in December (released on Jan. 6). Yet, while the 0.3% month-over-month (MoM) decline made investors feel like the inflation battle was over, please remember that the devil is in the details.
Please see below:
Source: Eurostat
To explain, the red rectangle above shows that energy prices declined by 6.5% MoM in December, which unsurprisingly, drove the headline CPI’s decline. Conversely, the dark blue bar above shows that core inflation increased by 0.7% MoM, which marked a 6.9% YoY increase and a new 2022 high. Furthermore, if you focus your attention on the light blue rectangle, you can see that Eurozone core inflation has increased YoY in every month since July.
Therefore, when the news media puts out a headline along the lines of “Euro area inflation slows to 9.2% in December,” the crowd shoots first and asks questions later. In other words, they buy the narrative without doing their homework.
So, while the recent economic data and Fed officials have been profoundly hawkish, investors’ expectations materially contrast the fundamental realities. Likewise, while the crowd cried wolf about a recession in July and October, we warned that their pessimism was premature. We wrote on Dec. 7:
The red line above tracks the U.S. 10-2 spread, which subtracts the U.S. 2-Year Treasury yield (2Y) from the U.S. 10-Year Treasury yield (10Y). In a nutshell: when the 2Y exceeds the 10Y, it's the bond market's way of warning about a forthcoming recession; and the development occurs because the 2Y is pricing in a higher U.S. federal funds rate (FFR), while the 10Y is pricing in weaker economic growth.
Also, with yield curve inversion (10Y < 2Y) the talk of the town in recent days, the narrative proclaims that a recession is imminent. But, that's not what we see….
The 10-2 spread is becoming more negative, and the last three recessions did not occur when the spread was declining.
To that point, the 10-2 spread turned negative in December 1988, and the recession arrived in July 1990 (~20-month lag). The 10-2 spread also turned negative in February 2000 and the recession arrived in February 2001 (~12-month lag). In addition, the 10-2 spread turned negative in February 2006 and the recession arrived in December 2007 (~22-month lag)….
The moral of the story is that the 10-2 spread needs to turn positive before recession fears are valid.
As such, with recession fears abating, the fundamentals continue to unfold as expected. However, the crowd still misses the mark as it relates to a higher FFR. With the U.S. labor market and consumer spending still resilient, the economic backdrop supports higher interest rates, not lower.
Please see below:
To explain, the Atlanta Fed increased its fourth-quarter real GDP growth estimate (the green line above) from 3.8% on Jan. 5 to 4.1% on Jan. 10. The report stated:
“The nowcasts of fourth-quarter real personal consumption expenditures growth and fourth-quarter real gross private domestic investment growth increased from 3.2 percent and 5.8 percent, respectively, to 3.5 percent and 6.8 percent, respectively.”
Similarly, S&P Global reported on Jan. 11 that Q4 real GDP could be even more hawkish.
Please see below:
To explain, the blue and red lines above track the dollar value of S&P Global’s monthly and three-month moving average of expected real GDP. As you can see, both metrics continue to hit higher highs, despite investors’ hopes for demand destruction and 2023 rate cuts. Moreover, Renaissance Macro wrote on Jan. 11:
“S&P Global’s Monthly U.S. real GDP measure jumped sharply in October and November. Over these two months, real GDP has advanced 5.5% SAAR. If we assume zero growth in December, Q4 GDP (average of Oct-Dec against average of Jul-Sep) would still climb 3.3% at an annual rate. Strong.”
Therefore, please remember that U.S. real GDP growth was running at roughly 2% pre-pandemic, and with the U.S. unemployment rate at a ~50-year low and the YoY core CPI near a 40-year high, investors’ pivot expectations are out of whack with fundamental reality.
Finally, we’ve warned repeatedly that wage inflation is the canary in the coal mine. In nutshell: wages are sticky and don’t jump around as much MoM as oil and commodity prices. Furthermore, higher wages allow Americans to absorb price increases that match their salary increases. So, if wages run at 5%+, it’s nearly impossible to reduce output inflation below 5%.
Speaking of which, Indeed updated its Wage Tracker on Jan. 10. An excerpt read:
“Posted wages grew 6.3% YoY in December 2022, a pace more than twice December 2019’s measurement of 3%. Gains in posted wages remain strong but continued to decline coming in below November’s 6.5% rate.”
Consequently, while wage inflation declined by 20 basis points YoY in December, a metric north of 6% is more than 3x the Fed’s desired target. On top of that, continued declines at this pace would take nearly 22 months for Indeed’s measure of wage inflation to fall to 2%. As a result, the crowd materially underestimates the hawkish realities that should commence in the months ahead.
Overall, the CPI release garners a lot of attention, but one month’s print is meaningless from a medium-term perspective. Moreover, while the bulls don’t care about the details, the U.S. economy is far from the carnage that often coincides with dovish pivots; and while the gold price, like many risk assets, is happy to ride the upward momentum, a profound wake-up call should materialize when reality re-emerges.
How do you see CPI-day unfolding? Will the bulls push prices higher, or does the front-run on Jan. 11 set the stage for a reversal? And why are investors worried about missing a melt-up; do you buy their optimism?
Alex Demolitor
Precious Metals Strategist