Gold at a Crossroads of Hawkish Fed and High Inflation

So, so you think you can tell heaven from hell, a bull market from a bear market? It’s not so easy, as gold seems to be at a crossroads. On the one hand, accelerating inflation should take gold higher, especially that the real interest rates stay well below zero. On the other hand, a hawkish Fed should send the yellow metal lower, as it would boost the expectations of higher bond yields. The Fed’s tightening cycle increases the interest rates and strengthens the US dollar, creating downward pressure on gold.

However, gold is neither soaring nor plunging. Instead, it seems to be in a sideways trend. Indeed, as the chart below shows, gold has been moving in a trading zone of $1,700-$1,900 since September 2020.

Now, the obvious question is: what’s next? Are we observing a bearish correction within the bull market that started in late 2018? Or did the pandemic and the following economic crisis interrupt the bear market that begun in 2011? Could a new one have started in August 2020? Or maybe gold has returned to its sideways trend from 2017-2018, with the trading corridor simply situated higher?

Oh boy, if I had the answers to all the wise questions that I’m asking! You see, the problem is that the coronavirus crisis was a very special recession – it was very deep but also very short. So, all the golden trends and cycles have intensified and shortened. What used to be years before the epidemic, took months this time. Welcome to a condensed gold market!

Hence, I would say that the peak of July 2021 marked the end of the bull market which started at the end of 2018, and triggered a new bear market, as traders decided that the vaccines would save the economy and the worst was behind the globe. This is, of course, bad news for all investors with long positions.

I didn’t call the bear market earlier, as the combination of higher inflation and a dovish Fed was a strong bullish argument. However, the June FOMC meeting and its dot-plot marked a turning point for the US monetary policy. The Fed officials started talking about tapering, divorcing from its extraordinary pandemic stance.

So, I’ve become more bearish in the short-to-medium term than I was previously. After all, gold doesn’t like the expectations of tapering quantitative easing and rising federal funds rate. The taper tantrum of 2013 made gold plunge.

Nonetheless, the exact replay of the taper tantrum is not likely. The Fed is much more cautious, with a stronger dovish bias and better communication with the markets. The quantitative tightening will be more gradual and better announced. So, gold may not slide as abruptly as in 2013.

Another reason for not being a radical pessimist is the prospects of higher inflation. After all, inflation is a monetary phenomenon that occurs when too much money is chasing too few goods – and the recent rate of growth of the broad money supply was much higher than the pace needed to reach the Fed’s 2% target. The inflationary worries should provide some support for gold prices. What gold desperately needs here is inflation psychology. So far, we have high inflation, but markets remain calm. However, when higher inflation expectations set in, gold may shine thanks to the abovementioned worries about inflation’s impact on the economy – and, thanks to stronger demand for inflation hedges.

In other words, gold is not plunging because the Fed is not hawkish enough, and it’s not rallying because inflation is not disruptive enough. Now, the key point is that it’s more likely that we will see a more hawkish Fed (and rising interest rates) sooner than stagflation. As the chart below shows, the real interest rates haven’t yet started to normalize. When they do, gold will suffer (although it might not be hit as severely as in April 2013).

Therefore, gold may decline shortly when the US central bank tapers its asset purchases (and the bond yields increase) while the first bout of inflation softens. But later, gold may rise due to the negative effects of rising interest rates and the second wave of higher inflation.

In other words, right now, the real economy is thriving, so inflation is not seen as a major problem, as it is accompanied by fast GDP growth. However, the economy will slow down at some point in the future (partially because of higher inflation) – and then we will be moving towards stagflation, gold’s favorite macroeconomic environment.

Thank you for reading today’s free analysis. We hope you enjoyed it. If so, we would like to invite you to sign up for our free gold newsletter. Once you sign up, you’ll also get a 7-day no-obligation trial for all our premium gold services, including our Gold & Silver Trading Alerts. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care.

 

Gold, USDX: Did Powell Spoil the Party?

The War on Debt

With Jerome Powell, Chairman of the U.S. Federal Reserve (FED), struggling to adequately define “transitory” during his press conference on Jul. 28, the market narrative has shifted from ‘hawkish FED’ to ‘dovish FED.’ And with the U.S. dollar bearing the brunt of investors’ wrath, the ‘all-clear’ sign flashed in front of the PMs. However, with post-FED rallies mainstays in the PMs’ historical record, the recent euphoria is much more semblance than substance. Thus, while Powell’s persistent patience elicits fears of financial repression, today’s economic environment lacks many of the qualities that made the gambit viable in the past.

To explain, financial repression includes measures such as direct government financing (the FED prints money and lends it directly to the U.S. Treasury), interest rate caps (yield curve control) and extensive oversight of commercial banks (reserve requirements, controlling the flow of credit). In a nutshell: governments use the strategy to keep interest rates low and ensure that they can finance their debt. And with the U.S. federal debt as a percentage of GDP currently at 128% (updated on Jul. 29), some argue that’s exactly what’s happening. Moreover, with the U.S. 10-Year real yield hitting an all-time low of -1.15% on Jul. 28, is the FED simply turning back the clock to the 1940s?

To explain, during World War Two, surging inflation helped the U.S. government ‘inflate away’ its debt. Think of it like this: if an individual borrows $100 at a 2% interest rate and repays the balance in full after one year, the total outlay is $102. However, if inflation is running at 4% (negative real yield), putting that money to work should result in an asset that’s worth $104 by the end of the year. As a result, the individual nets $2 (104 – 102) due to the inflation rate exceeding the nominal interest rate. And as it relates to the present situation, if the FED keeps real yields negative, then asset price inflation and economic growth should outpace nominal interest rates and allow the U.S. government to ‘inflate away’ its debt.

However, the strategy is not without fault. For one, financial repression occurs at the expense of bondholders. And with pension funds still required to meet the guaranteed outlays for retirees, suppressing bond yields hampers their ability to match assets and liabilities without incurring more risk.

More importantly, though, the FED doesn’t control the long end of the U.S. yield curve. For one, the FED owns roughly 23% of the U.S. Treasury market, and it has a monopoly on confidence, not long-term interest rates. Second, the U.S. 10-Year Treasury yield has dropped because investors fear that the Delta variant and/or the FED’s forthcoming taper will depress the U.S. economy. And eager to front-run the potential outcome, bond investors have positioned for slower growth, lower inflation, and, eventually, a reenactment of the FED cutting interest rates.

For context, even Powell himself admitted on Jul. 28 that the decline has caught him off-guard:

Source: Bloomberg

Likewise, following WW2, the U.S. government implemented structural reforms that are not present today. For example, prudent fiscal policy emerged in the late 1940s, with the government reducing spending and prioritizing debt reduction. In stark contrast, today’s U.S. government is already finalizing an infrastructure package and the federal deficit as a percentage of GDP is still growing. For context, a deficit occurs when the governments’ outlays (expenditures) exceed its tax receipts (revenues).

Please see below:

To explain, the green line above tracks the U.S. federal surplus/deficit as a percentage of GDP. If you focus on the period from 1943 to 1950, you can see that after the deficit peaked in 1943, reduced spending and strong GDP growth allowed the green line to move sharply higher. Conversely, if you analyze the right side of the chart, you can see that current spending still outpaces GDP growth (green line moving lower), and stoking inflation is unlikely to solve the problem.

U.S. 10-Year Treasury Yield Decouples… By a Lot

Circling back to the bond market, the U.S. 10-Year Treasury yield currently trades at an all-time low relative to realized inflation.

Please see below:

To explain, the scatterplot above depicts the relationship between the headline Consumer Price Index (CPI) and the U.S. 10-Year Treasury yield (available data dates back to 1967). For context, the headline CPI is plotted on the horizontal axis, while the U.S. 10-Year Treasury yield is plotted on the vertical axis. If you analyze the dot labeled “Current Reading,” you can see that the U.S. 10-Year Treasury yield has never been lower when the headline CPI has risen by 5% or more year-over-year (YoY). In fact, even if the headline CPI declined to the FED’s 2% YoY target, the U.S. 10-Year Treasury yield at 1.27% would still be the lowest relative reading of all time.

However, it’s important to remember that different paths can still lead to the same destination. For example, if inflation turns out to be a paper tiger, a profound decline in inflation expectations will have the same negative impact on the PMs as a sharp rise in the U.S. 10-Year Treasury yield.

Please see below:

To explain, the green line above tracks the U.S. 10-Year Treasury yield, while the red line above tracks the U.S. 10-Year breakeven inflation rate. If you analyze the gap on the right side of the chart, it’s a decoupling of the ages. However, while the two lines are destined to reconnect at some point, if the red line falls off a cliff, the impact on the PMs will likely mirror the 2013 taper tantrum. For context, gold fell by more than $500 in less than six months during the event.

Finally, and most importantly, U.S. Treasury yields are only one piece of the PMs’ bearish puzzle. Knowing that one shouldn’t put all their eggs in one basket, betting the farm on the U.S. 10-Year Treasury yield would be investing malpractice. That’s why self-similar patterns, ratios, technical indicators, the relative behavior of the gold miners, the USD Index and the FED’s taper timeline are all prudently considered when forming our investment thesis.

As an example, if gold had a perfect correlation with the U.S. 10-Year real yield, the yellow metal would be trading at roughly $1,940. However, with many other factors worthy of our attention, gold’s material underperformance indicates that a mosaic of headwinds undermines its medium-term outlook.

In conclusion, Powell’s party was in full swing on Jul. 29, as the PMs and the USD Index headed in opposite directions. However, with the yellow metal still confronted with a tough road ahead, the fundamental outlook remains dicey over the next few months. For example, with the all-time imbalance in the U.S. Treasury market eliciting little optimism, it took Powell’s dovish remarks to ignite the recent fervor. And with both developments likely to reverse in the coming months, the PMs’ upside catalysts may fade with the summer sun.

Thank you for reading our free analysis today. Please note that the above is just a small fraction of today’s all-encompassing Gold & Silver Trading Alert. The latter includes multiple premium details such as the targets for gold and mining stocks that could be reached in the next few weeks. If you’d like to read those premium details, we have good news for you. As soon as you sign up for our free gold newsletter, you’ll get a free 7-day no-obligation trial access to our premium Gold & Silver Trading Alerts. It’s really free – sign up today.

For a look at all of today’s economic events, check out our economic calendar.

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Sunshine Profits: Effective Investment through Diligence & Care

* * * * *

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits’ associates only. As such, it may prove wrong and be subject to change without notice. Opinions and analyses are based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are deemed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski’s, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits’ employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

 

Behavior of Inflation and Bond Yields Seems… Contradictory

The markets hide many mysteries. One of them is the recent slide in the long-term bond yields. As the chart below shows, both the nominal interest rates and the real interest rates have been in a downside trend since March (with a short-lived rebound in June). Indeed, the 10-year Treasury yield reached almost 1.75% at the end of March, and by July it decreased to about 1.25%, while the inflation-adjusted yield dropped from -0.63% to about -1%.

What’s intriguing, this drop happened despite the surge in inflation. As you can see in the chart below, the seasonally adjusted annual CPI inflation rate surged to 5.3% in June, the highest level since the Great Recession. Even as inflation soared, the bond yields declined.

Why is that? Are bond traders blind? Don’t they see that the real interest rates are deeply negative? Indeed, the TIPS yields are the lowest in the history of the series (which began in 2003), while the difference between the nominal 10-year Treasury yields and the CPI annual rates is the lowest since June 1980, as the chart below shows.

The pundits say that the decline in the bond yields suggests that inflation will only be temporary and there is nothing to worry about. This is what the central bankers repeat and what investors believe. However, history teaches us that the bond market often lags behind inflation, allowing the real interest rates to plunge. This happened, for example, in the 1970s (see the chart above), when the bond market was clearly surprised by stagflation.

Another issue here is that the central banks heavily influence the bond markets through manipulation of interest rates and quantitative easing, preventing them from properly reacting to inflation. Actually, some analysts say that the bond market is the most manipulated market in the world. So, it doesn’t have to predict inflation properly.

Implications for Gold

What does the divergence between the bond yields and inflation imply for gold? Well, as an economist, I’m tempted to say “it depends”. You see, if inflation is really temporary, it will start declining later this year, making the real interest rates rise. In that case, gold would suffer (unless inflation decreases together with the pace of economic growth).

It might also be the case that the divergence will narrow as a result of the increase in the nominal interest rates. Such a move would boost the real interest rates and create downward pressure on gold.

However, if inflation turns out to be more persistent than expected, investors will fear an inflation tail risk, and they will be more eager to buy gold as an inflation hedge. As I’ve explained, the decline in the bond yields doesn’t have to mean low inflation expectations. It may also indicate expectations of slower economic growth. Combined with high inflation, it would imply stagflation, a pleasant environment for gold.

Another bullish argument for gold is the observation that the price of gold has recently lagged the drop in the real interest rates, as the chart below shows. So, it might be somewhat undervalued from the fundamental point of view.

However, given the upcoming Fed’s tightening cycle and the record low level of real interest rates, I would bet that the above-mentioned rates will increase later this year, which should send gold prices lower. But if they rise too much, it could make the markets worry about excessive indebtedness and release some recessionary forces. Then, the current reflation could transform into stagflation, making gold shine. So, gold could decline before it rallies again.

If you enjoyed today’s free gold report, we invite you to check out our premium services. We provide much more detailed fundamental analyses of the gold market in our monthly Gold Market Overview reports and we provide daily Gold & Silver Trading Alerts with clear buy and sell signals. In order to enjoy our gold analyses in their full scope, we invite you to subscribe today. If you’re not ready to subscribe yet though and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care

 

The Inadvertent Debt/Inflation Trap – Is It Time To Face The Music?

What happens to a global economy after 10+ years of global central bank efforts to support a recovery attempt after a massive credit/debt collapse originates from a prior credit/debt housing bubble?  What happens to global economies when they become addicted to easy money policies and central bank activities that support greater and greater risk-taking? What is the end result of these actions after more than 10+ years of excess and central bank support for the markets?

Let’s play this out a bit to think about how the current market environment may be similar to what happened in the mid/late 1990s and see if we can come to any real conclusions. Remember, we are using our research and technical analysis skills to play a “what if” scenario in this research article.  Our current trading systems have not warned us of any major Bearish price trends of price collapses that may take place. Our systems are still trading the US markets based on current market trends.  This research is completely speculative in the sense that we are trying to identify “what if” scenarios based on events in the recent past.

One thing that our research team has been discussing over the past 8+ months, since shortly after the US elections in November 2020, is the idea that the new US President/US Federal Reserve may engage in policies that are initially perceived as supportive of the global markets in a post-COVID world – yet may engage in very dangerous end results.  An example of this is the continued stimulus efforts for a world that has somewhat moved beyond the initial COVID shock and has transitioned into a new form of economic activity.  Another example would be the US Federal continuing to act in a manner to support the US equities market while Inflation and consumer activity have recently shown extreme pricing/buying activities.

One idea that my research team suggested is this activity may be similar to President Ronald Reagan’s Star-Wars project in how Reagan was able to prompt a spending excess between the US and Russia which eventually broke the Russian economy.  The process between that event and what is happening right now are strangely similar.

The Strange Outcome Of Global Central Bank Policies – The US Is The Clear Winner

The US and many foreign central banks have pushed the envelope of easy money policies over the past 8+ years by continuing to run programs to support a stronger economic outcome.  The focus has been on creating an inflationary target to start a more traditional shift away from the ongoing easy money policies.  Inadvertently, these global central banks may have created and supported one of the biggest asset shifts/bubbles in the past 50+ years.

The COVID-19 virus event may have actually pushed the US Federal Reserve and foreign global central banks into an inadvertent process of creating a massive inflation trap at a time when the global economy and corporate world was banking on much more mild inflationary trends.  The reflation trade that came after June 2020 is likely to have pushed assets, commodities, credit & debt cycles beyond any conceivable scope of reason, while putting unimaginable pressure on foreign central banks in Asia, South America, Africa, and most of the emerging markets.

The incredible rally in commodities, asset values (homes, stocks, US equities, and others) prompted capital to shift towards the strongest and most capable outcomes on the planet.  This created a liquidity trap in many foreign markets where traders moved assets into US equities, Cryptos, US ETFs, and other assets while shunning less dynamic and secure global assets.

https://www.thetechnicaltraders.com/wp-content/uploads/2021/07/2021-07-16_WorldMarketCap-1.jpg

(Source: https://data.worldbank.org/indicator/CM.MKT.LCAP.CD)

What has transpired over the past 10+ years is that the US equities markets have risen to levels above the 2007~08 peak levels. US equities have also continued to skyrocket higher as foreign investors seek to move assets into US Dollar-based equities and ETFs, and away from stagnant, under-performing local equities and assets.  Currently, the US stock market total capitalization makes up nearly $48T of the total global market capitalization. The next closest foreign market exchange is China, which makes up nearly $12T in total capitalization.

https://www.thetechnicaltraders.com/wp-content/uploads/2021/07/2021-07-16_GlobalStockMarketCap-2.jpg

(Source: https://www.advratings.com/companies/the-largest-stock-exchanges)

When one takes into consideration the massive expansion of state, corporate, consumer, and global credit/debt that has taken place over the past 10+ years in China (and the risks associated with servicing that debt as well as increased commodities/asset costs which have taken place over the past 24+ months) one starts to consider if China may suddenly turn into Russia of the late 1990s.

At that time, the inflation rate in Russia reached over 120% and took place after a number of key economic events set up an almost perfect storm. The aftermath of this event continued to create moderate global market crisis events.

  • 1973 & 1979 Energy/Oil Crisis
  • 1982 US Interest Rate Peak/Recession
  • 1983 Israel Bank/Stock Crisis
  • 1987 Black Monday
  • 1991 India Economic Crisis
  • 1994 Mexican Peso Crisis
  • 1998 Russian Financial Crisis

Although the names and dates of these events are much different than what is set up today, imagine the 1973/79 oil/energy crisis was the peak in oil prices in 2018.  Imagine the 1982 peak in US interest rates was the peak in interest reached in 2018.  Imagine the Israel Bank/Stock Crisis and the 1987 Black Monday was the 2020 COVID crisis.  Imaging the 1991 India Economic Crisis, and 1994 Mexican Peso Crisis were the post-COVID economic and current crisis events that have taken place over the past 14+months throughout the world.

Now, imagine that China is the new 1998 Russian Financial Crisis taking place.  One of the biggest and strongest economies in the world is now at risk of entering a severe inflationary period where excess credit/debt of the past few decades may be washed away – just like what happened in Russia.

https://www.thetechnicaltraders.com/wp-content/uploads/2021/07/russia_inflation_rate2.jpg

(Source: https://www.timetoast.com/timelines/financial-crisis-1900s-2017)

Lastly, remember what came about after these events took place and how isolated the world was from the Russian economic collapse in the late 1990s. The world is not so isolated any longer.  If China initiates a credit/debt crisis event, there is a very strong likelihood that the global markets will react to this event moderately violently.

The Hang Seng Index May Foretell A Collapse In The Making

The typical process of the unwinding of this excess credit/debt/liability usually takes place in a common process.  First, individuals, corporations, and state-run agencies load up on cheap debt while inflation and costs are relatively consistent.  Then, as the economy heats up, inflation, commodity prices, and equipment/material costs begin to skyrocket – eating into operational profits for these entities. Meanwhile, the need to service the debt/credit persists.  As fractures in the system become evident (usually starting with isolated debt defaults by some large entities), investors start pricing greater risks into the credit/debt markets – further complicating the issues for these entities that are burdened with excess debt and diminishing profit margins.

Looking at the Russian Inflation Rate chart, above, any type of major inflationary increase will usually push these entities over the edge in terms of sustainability.  Once the cost of refinancing the debt and ongoing profit margins have been squeezed beyond limits, the crisis escalates to a point of implosion.

https://www.thetechnicaltraders.com/wp-content/uploads/2021/07/HSI_W_F.png

Given the rise in Real Estate, Commodities, Oil/Energy costs, and other factors, we believe this event may be unfolding right before us in current market trends.  China may be the focus of what Russia was in the late 1990s with extensive credit/debt issues, massive imports of raw materials, commodities, and food, and extensive global foreign debt/credit issues related to the Belt Road project.  If a global event were to unfold, which we are only speculating MAY happen at this point, China and Asia would become the focal point for this process.

More than ever, right now, traders need to move away from risk functions and start using common sense.  There will still be endless opportunities for profits from these extended price rotations, but the volatility and leverage factors will increase risk levels for traders that are not prepared or don’t have solid strategies.  Don’t let yourself get caught in these next cycle phases unprepared.

Want to know how our BAN strategy is identifying and ranking various sectors and ETFs for the best possible opportunities for future profits? Please take a minute to learn about my BAN Trader Pro newsletter service and how it can help you identify and trade better sector setups.  My team and I have built this strategy to help us identify the strongest and best trade setups in any market sector.  Every day, we deliver these setups to our subscribers along with the BAN Trader Pro system trades.  You owe it to yourself to see how simple it is to trade 30% to 40% of the time to generate incredible results.

As something entirely new, check out my new initiative URLYstart to learn more about the youth entrepreneurship program I am developing. This is an online program of gamified entrepreneurship designed to introduce and inspire kids to start their own businesses. Click-by-click, each student will be guided from their initial idea, through the startup process all the way to their first sale and beyond. Along the way, our students will learn life lessons such as communication, perseverance, goal setting, teamwork, and more. My team and I are passionate about this project and want to reach as many kids as possible!

Have a great day!

For a look at all of today’s economic events, check out our economic calendar.

Chris Vermeulen
Chief Market Strategist
www.TheTechnicalTraders.com

 

US Recovery Plan Will Support Recovery and Raise Long-Run Economic Growth Potential From 1.9%

Since the USD 1.9trn American Rescue Plan was signed into law in March, the Biden administration is pursuing two complementary pillars of its three-pillar “Build Back Better” agenda: i) the American Jobs Plan (with an earlier bipartisan compromise around a curtailed USD 1.2trn over eight years before recent setbacks), and ii) the American Families Plan (proposed USD 1.8trn).

The American Jobs Plan channels public funding towards enhancing physical and digital infrastructure, investing in research and development, shoring up supply chains and strengthening care systems. The American Families Plan aims to significantly raise federal spending in priority areas such as childcare, paid leave, pre-kindergarten, community college and healthcare.

The recovery plan is important not only for economic recovery but also for addressing structural bottlenecks

The administration’s programme is critical not only to provide near-term support for the economic recovery but also to address long-standing structural bottlenecks in the US economy. By enhancing the economy’s productive capacity, supporting domestic demand and tackling infrastructure deficits as well as structural weaknesses with respect to the social safety net, the programme supports a more inclusive and sustainable economic rebound and raises economic growth potential.

In our June 2021 Sovereign Interim Outlook, Scope Ratings projected the US economy to recover robustly, with 6.2% growth in 2021 (raised 2.2pps from our December 2020 projections) before 4.8% in 2022. After the 3.5% economic contraction of 2020, GDP is expected to have exceeded pre-crisis output as of Q2 2021, well ahead of the pace of recoveries in most European economies, including that of France and the United Kingdom. On the basis of the public investment programme, there is upside risk to our department’s prevailing US growth potential estimate of 1.9% – with potential output growth having otherwise seen secular decline since the turn of the century.

The spending programme comes at significant fiscal cost

The spending programme comes at a significant fiscal cost, however. The Committee for a Responsible Federal Budget estimates that the comprehensive package may amount to an aggregate of USD 6.7trn over 10 years. The US government has proposed offsetting measures such as an increase in the corporate income tax rate from 21% to 28%, enhanced tax enforcement and higher taxation of high-income households. These measures might generate savings of USD 3.3trn, leaving USD 3.5trn of unfunded costs, absent further revenue-raising measures.

In addition, mandatory expenditure linked to the healthcare system is likely to increase given the increase in federal spending on Medicaid and Medicare due to the Covid-19 health crisis and as more Americans seek benefits under programmes, barring reforms of the system.

US public debt to rise further, but accommodative financing conditions manage costs of borrowing

Presently, we expect US public debt to rise to above 135% of GDP in forthcoming years, from 108% in 2019 and only 65% as of 2007, exacerbating public finance weaknesses and stressing the United States’ AA credit ratings. Gross government financing requirements are estimated to stay around or above an elevated 40% of GDP per year through 2026. At the same time, prevailing accommodative financing conditions mitigate costs of borrowing, with 10-year government yields having backtracked to around 1.2% amid concern of a slowdown in the global recovery, from March highs of nearly 1.8%.

While benefits of a well-tailored investment programme at this stage are high and the cost of debt is low, it is critical that additional debt incurred nonetheless translates to tangible improvements of growth potential and addresses structural bottlenecks such as rising social inequality and problems of social mobility.

A return to a more balanced budget position remains crucial to ensuring benign funding costs and as the debt ceiling looms

While the United States still has meaningful fiscal space due to the dollar-based global financial system and the unparalleled status of US treasuries as the international risk-free asset, a return to a more balanced budget position after this crisis and reduction of contingent liabilities are nonetheless crucial to ensuring continued benign funding costs, especially as the Federal Reserve considers its exit strategies from crisis policies and as elevated deficits present risks after coming reinstatement of the US debt ceiling.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Senior Analyst at Scope Ratings, contributed to writing this commentary.

Lower for Longer

While the existing vaccines seem to have lost some of their ability to prevent the illness, they remain a power prophylactic against hospitalization and death. Nevertheless, new social restrictions have been introduced in some high-income countries, even those like Israel, that have been fairly successful in vaccinating a large part of their population.

The virus is once again raising the prospects of slowing the economic recovery that was unevenly unfolding. The preliminary July PMI for Australia, UK, France, and the US disappointed. Expectations for the trajectory of monetary policy are being impacted. Consider that the implied yield of the December 2022 Eurodollar futures fell to 40 bp in the middle of last week from 55 bp on July 1.

A similar futures contract in the UK, the December 2022 short-sterling implied yield fell from 58 bp in mid-July to almost 40 bp on “Freedom Day” as the UK dropped all social restrictions and mask requirements. The implied yield of the December 2022 Bank Acceptances in Canada fell 20 basis points from July 14 to nearly 105 bp ahead of the weekend. In Australia, the December 2022 bill futures contract’s implied yield fell a little over 60 bp on July 6 to 36 bp last week.

The December 2022 Euribor futures contract has been considerably steadier as it is widely accepted that the European Central Bank will not lift rates until after 2023. The implied yield has been confined to a -42 bp to – 50 bp trading range since the end of April. The yield finished last week at -49 bp, falling about five basis points since the ECB meeting. The ECB’s new forward guidance signaled that bond purchases and low rates will prevail until the staff forecasts that the 2% target can be sustained. In June, the staff forecasts projected 2023 CPI at 1.4%.

The signal of lower for longer helped drive European bond yields to new 3-4 month lows. The French 10-year bond yield had been offering a positive yield since the second half of April but recently moved back below zero. One has to pay Greece 50 bp to lend to it for two years, which is a little more than one would pay to Italy for the same maturity.

Greece takes about 15 bp a year from those lending to it for five years, while Italy’s five-year yield has dipped below zero for the first time since early April. The amount of negative-yielding bonds in the world has increased to almost $16 trillion from below $13 trillion in late June, and that does not include Japan’s 10-year bond, where the benchmark yield is less than a basis point.

The ECB’s dovishness likely minimizes the impact of the preliminary July CPI figures. In July 2020, the eurozone saw consumer prices fall by 0.4% on the month and again in August. This speaks to a likely acceleration of the year-over-year pace from 1.9% in June. Also, note that since at least 2000, prices gained less in July than in June (and consistently rose more in August than July).

The monthly increase in June was 0.3%. The Bloomberg survey shows economists anticipate sharp month-over-month declines in Italian and Spanish prices. French CPI is also expected to have fallen slightly in July. German inflation may have ticked up. These considerations suggest the year-over-year rate may have edged above 2%.

The eurozone will provide its first estimate of Q1 GDP at the same time as the CPI figures on July 30. Recall that in Q4 19, before the pandemic struck, the eurozone economy was stagnant. Last year contracted in H1 before recovering in Q3. However, unlike the US experience, the eurozone economy contracted against in Q4 20 and Q1 21. Despite the spread of the Delta mutation and the floods in parts of Europe, including Germany, the recovery now appears to be on more solid footing, and the EU Recovery Funds are at hand. The regional economy likely expanded around 1.4%-1.5% in Q2 and is poised to accelerate further here in Q3.

The highly contagious, though less lethal mutation (if vaccinated), has pushed investors to reconsider the recovery theme that had two drivers last November, the US election and the vaccine announcement. Of course, this does not mean that it is the only development in the market, but it seems to be a relatively new and powerful one. The US dollar rallied as the pandemic first struck, partly as a safe haven as US Treasuries were bought and partly as a function of the unwinding of dollar-funded purchases of risk assets (e.g., emerging markets).

When things began to stabilize at the end of last March 2020, and the NBER now dates the end of the US recession as April 2020, the dollar trended lower and accelerated into the end of the year and began to recover in early January. From the end of March through December last year, the Antipodeans and Scandis led the move against the greenback and appreciated roughly 20%-25% against the US dollar. These currencies are often perceived to be levered to world growth and are often more volatile than the other majors. Over the past three months, they have been the weakest, losing 3.0-6.50%.

The opposite is also true in the sense that the Swiss franc and Japanese yen, other currencies often used for funding, hence the appearance of safe-haven appeal, were the worst performers against the dollar in the last nine months of 2020 (rising about 8.25% and 4.5% respectively). However, over the past three months, they have been among the most resilient in the face of the dollar’s surge. The Swiss franc is off less than three-quarters of a percent, while the yen is off by about 2.4%.

A challenge for investors and policymakers is the evolution of the virus that renders some of the high-frequency data rather dated and arguably less impactful outside of the headline risk posed. The Federal Reserve has succeeded in securing for itself much room to maneuver and is not tied to a particular time series, like the monthly jobs report or data point. The FOMC statement is likely to hardly change from the previous one.

Discussions about the pace and composition of the Fed’s bond-buying will continue. Still, Fed Chair Powell was speaking for the central bank when he told Congress recently that the bar to adjust the purchases (substantial further progress toward the Fed’s targets) has not been met.

The Jackson Hole symposium at the end of August has long been seen as the first realistic window of opportunity for the Fed to signal its intention to slow, possibly alter the composition of its bond purchase, and shape it more formally at the September FOMC meeting. Ahead of Jackson Hole, there is one more jobs report, and the early call is for around a 750k increase.

Reporters may try to draw Powell out but are unlikely to have much more success than the US Senators and Representatives. There is ongoing interest in the size of the reverse repo facility, for which the Fed now pays five basis points at an annualized rate, the same as a six-month bill. In addition, Powell pushed back against suggestions by some officials that the central bank’s MBS purchases are lifting house prices beyond the access of many American families. Will reporters press him on this or the buying of inflation-protected securities that arguably distort the price discovery process and the break-even metric?

Stable coins’ regulatory framework may be questioned. Recall that just before Biden took office, the Comptroller of the Currency allowed federally chartered banks to used distributed ledgers (blockchain) and conduct business with stable coins. There is a push to treat stable coins as securities for regulatory purposes. While the ECB recently announced it was going forward with a research and design phase of its development of a digital euro, the Federal Reserve’s report is expected in September. Powell said what many officials seem to believe that the introduction of a digital dollar would likely dry up demand for stable coins and crypto.

The day after the FOMC meeting concludes, the US reports its first estimate of Q2 GDP. The median forecast in Blomberg’s survey has crept up in recent days to 8.5% at an annualized pace, up from 6.4% in Q1. The NY Fed’s GDPNow model puts growth at 3.2%, while the Atlanta Fed’s model is closer to the market at 7.6%, while the St. Loius Fed Nowcast stands at 9%.

Even before this surge in the virus in the US, where about half of the adult population is fully vaccinated, we suggested there was a reasonable chance that Q2 marks the peak in growth. Fiscal policy will increasingly be a drag, pent-up consumer demand will be satiated. Monetary policy is near a peak. Perhaps the recent increase in the rate paid on deposits at the Fed and on the reverse repo facility and the recent sales of corporate bonds bought in 2020 mark the end of the easing cycle. We have also underscored the restrictive impact of doubling the oil price since the end of last October.

While there does not appear to be an iron law, it would not be surprising to see price pressures peak with a bit of a lag. This dovetails with the timeframe suggested by both Powell and Yellen. Some recent industry data suggests that the US used car market (accounting for around a third of the recent monthly increases in CPI) is normalizing in terms of inventory, and prices have softened in the wholesale markets.

We note that input prices and prices paid components Markit PMI have fallen in June, and the preliminary report suggests a further decline is taking place this month. Airfare and the price of hotel accommodations, and food out of the house, appear to be a one-off adjustment rather than persistent increases.

The US will report June personal income and consumption figures ahead of the weekend, but the data will already be embedded in the GDP estimate. On the other hand, the PCE deflator, which the Fed targets rather than the CPI, may draw attention. It is expected to post a sharp 0.7% increase on the month for around a 4.2% year-over-year. It rose by 0.4% in May and a 3.9% year-over-year rate. The core rate, which the Fed does not target but makes references from time to time, is expected to accelerate to 3.7% from 3.4%.

Lastly, the infrastructure debate in the US Senate looks to come to a head in the days ahead. It could, in turn, shape the political climate until next year’s midterm elections. The latest wrinkle is that what might serve as the basis of a compromise in the Senate may be rejected by a number of Democrats in the House. The failure to find a bipartisan solution for even the physical infrastructure components will not defeat the Biden administration but force it to rely on the reconciliation mechanism, which is confined to fiscal policy.

It would likely hamper the administration on non-budgetary fiscal issues. The debt ceiling looms. The Congressional Budget Office sees the Treasury running out of room to maneuver in October or November. Biden’s spearheading of a 15% minimum corporate tax rate might not need their approval, but the approval of 60 Senators may be needed for the other component of the global tax reform, the agreement to link the sales and taxes for the largest companies.

This article was written by Marc Chandler, MarctoMarket.

Russian Central Bank Governor Speaks at Press Conference

Below are the highlights of her comments:

RATE DECISION:

“The decision is based on a significant review of macroeconomic forecasts… The notable policy step we have taken is needed in order to bring inflation in line with the target.”

“Deposit and loan rates were not as quick to react to the policy rate adjustment as the OFZ bonds, today’s decision is aimed at speeding up this process.”

“The neutral (policy rate) range remains at 5-6% given inflation close to 4%… It is premature to say whether this rate hike is going to be the last one in the policy tightening cycle.”

“We considered the options of raising the rate by 50, 75, and 100 basis points.”

“We currently see the policy rate in the 6-7% range next year which will produce inflation at 4.0-4.5%.”

ECONOMIC GROWTH:

“Our policy will not harm economic growth rates.”

ROUBLE:

“Carry trade flows have slightly increased against the backdrop of the rate hike. This does not significantly affect the rouble exchange rate, in our view.”

“Equipment purchases using the national wealth fund money may also affect rouble exchange rate, such influence needs to be further evaluated, it is better to invest the fund’s money into projects that boost Russia’s economic potential.”

INFLATION:

“The first signs of inflationary pressure weakening appeared in the first half of July but this is not yet sufficient to talk about sustainable inflation slowdown.”

“We must not put up with elevated inflationary expectations so that they do not anchor on this high level.”

“We expect that in annual terms the decrease in inflationary pressure will become visible in autumn.”

“There are many reasons to analyse the inflation target, we will look at how the target is formulated, its level and whether it will be a point or a range. We will discuss this for a year with experts, academics, business representatives and the public.”

OUTLOOK REVISION:

“According to our forecasts, the OPEC+ oil output increase will add 0.1 percentage point to GDP growth in 2021 and 0.2-0.3 percentage point in 2022.”

“A good (grain) harvest may provide for more significant food price decline.”

“The state budget may be executed with some surplus.”

RISKS:

“There are signs of overheating in the unsecured loan market. Taking into account data for the last few months, we will decide on additional measures to cool down this segment.”

“Geopolitical risks are also something to which we continue to pay attention.”

BANK REGULATION:

“We are not changing our approach to bank regulation because of this (change in national wealth fund asset structure), but our banking regulation already includes measures aimed at making rouble deposits and loans more attractive and foreign currency ones less attractive.”

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE:

“ESG is one of the key factors that will have an ever increasing influence on Russia’s economy. We will regularly carry out stress tests in order to assess the impact of the carbon tax on our economy.”

For a look at all of today’s economic events, check out our economic calendar.

(Reporting by Darya Korsunskaya, Anastasia Lyrchikova and Tatiana Voronova; Writing by Olzhas AuyezovEditing by Katya Golubkova)

Gold’s Behavior in Various Parallel Inflation Universes

Inflation, inflation, inflation. We all know that prices have surged recently. And we all know that high inflation is likely to stay with us for a while, even if we assume that the CPI annual rate has already peaked, which is not so obvious. But let’s look beyond the nearest horizon and think about what lies ahead after months of high inflation, and what consequences it could have for the gold market.

From the logical point of view, there are three options. Inflation rates could accelerate further, leading to hyperinflation in an extreme case. They could remain more or less the same, resulting possibly in stagflation when the pace of GDP growth decelerates. And, finally, the rates of annual changes in the CPI could slow down, implying disinflation, or they could even become negative – in this scenario, we would enter the world of deflation. So, which of these “flations” awaits us?

Although some commentators scare us with the specter of hyperinflation, I would reject this variant. Surely, the inflation rate at 5% is relatively high, but it’s not even close to 50%, which is an accepted hyperinflation threshold. We also don’t see people getting rid of depreciating money as quickly as possible – instead, the demand for money has been rising recently (or, in other words, the velocity of money has been decreasing).

It’s also worth remembering that hyperinflation usually occurs when fiscal deficits are financed by money creation, especially when the government cannot raise funds through borrowing or taxes, for example because of a war or other sociopolitical convulsions. Sure, the budget deficits are partially monetized, but we are far from the situation in which the US government would be unable to collect taxes or find lenders ready to buy its bonds. Hence, gold bugs counting on hyperinflation may be disappointed – but I doubt that they would really want to live during the collapse of the monetary system.

The opposite scenario, i.e., deflation, is also unlikely. To be clear, asset price deflation is possible if some of the asset bubbles burst, but the absolute declines in the consumer prices, similar to those observed during the Great Depression, or even the Great Recession, are not very probable. The broad money supply is still increasing rapidly, the fiscal policy remains easy as never, and the Fed remains ultra-dovish and ready to intervene to prevent deflation. For deflation to happen, we would need to have the next global financial crisis which would severely hit the aggregate demand and oil prices.

Although there are significant vulnerabilities in the financial sector, it’s definitely too early to talk about significant deflation risks on the horizon. As with hyperinflation, this is bad news for gold, as the yellow metal performs well during the deflationary crises (although at the beginning, people usually collect cash, disposing of almost all assets).

So, we are left with two options. Inflation will either diminish to its previous levels (maybe to slightly higher readings than before the pandemic), and we will return more or less to the Goldilocks economy, or inflation will stay relatively high (although it may subside a bit), while the economic growth will slow down significantly (and more than inflation). It goes without saying that the latter option would be much better for gold than the former one, as gold doesn’t like periods of decelerating inflation rates and of a decent pace of economic growth (remember 1980 and the 1990s?). So, could gold investors reasonably ask whether we will experience disinflation or stagflation?

Well, the Fed believes that the current high inflation readings will prove to be temporary and we will return to the pre-epidemic era of low inflation. But you can’t step in the same river twice, and you can’t step in the same economy twice. You can’t undo all the monetary and fiscal stimulus nor the surge in the broad money supply and the public debt (see the chart below).

So, the pre-pandemic low inflation readings are not set in stone. And the impact of some deflationary forces could be exaggerated by the central bankers and the pundits – for example, the recent ECB research shows that “the disinflationary role of globalization has been economically small”.

Hence, I worry about stagflation. And I’m not alone. The results of the latest biannual survey of the chief U.S. economists from 27 financial institutions for the U.S. Securities Industry and Financial Markets Association also highlight the risks of high inflation and stagnation. They reveal that 87% of respondents consider “stagflation, as opposed to hyperinflation or deflation, as the bigger risk to the economy.”

Actually, the GDP growth is commonly projected to slow down significantly next year. For example, according to the recent Fed’s dot-plot, the pace of the economic growth will decline from 7% in 2021 to 3.3% in 2022. It’s still fast, but less than half of this year’s growth. And it’s likely to be slower, as the FOMC members tend to be overly optimistic.

The stagflation scenario could be positive for gold, as the yellow metal likes the combination of sluggish (or even negative) growth and high inflation. Indeed, gold shined in the 1970s, the era of The Great Stagflation. Of course, there are important differences between then and now, but the economic laws are immutable: the mix of easy fiscal policy and monetary policy superimposed on economic reopening is a recipe for overheating and, ultimately, stagflation.

However, so far, the markets have bet on transitory inflation. Moreover, they are focused on fast economic expansion and the Fed’s hawkish signals. But we could see more uncertainty later this year when higher interest rates and inflation hamper the economic activity. In that case, gold could get back on track.

Thank you for reading today’s free analysis. We hope you enjoyed it. If so, we would like to invite you to sign up for our free gold newsletter. Once you sign up, you’ll also get 7-day no-obligation trial of all our premium gold services, including our Gold & Silver Trading Alerts. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care.

 

Inflation Worries Overshadow Unilever’s Strong First Half, Hit Shares

Underlying sales for the maker of Dove soap rose 5% in the three months ended June 30, above 4.8% forecast by analysts.

It maintained its 3-5% sales growth forecast for the year, but rising prices of everything from crude to palm and soybean oil made the company cut its operating margin outlook to “about flat” from “slightly up” earlier and flag greater uncertainty surrounding that forecast.

The warning dragged shares of the FTSE 100-listed company down 6.2% by 13:45 GMT, wiping off nearly 7 billion pounds ($9.65 billion)of its market value, and making it the top loser on the index on Thursday.

Finance chief Graeme Pitkethly said he expected cost inflation to be in the high-teens in the second half, above the mid-teens rise anticipated earlier.

He said that since the company issued its guidance in the first quarter, crude oil prices had risen 12%, soy bean oil 21%; while freight and transportation costs had risen and 4% and 7%, respectively.

Unilever said that besides accelerating price hikes, it was introducing pack changes and narrowing promotions in the second half in response to rising costs.

The company raised prices by 1.6% in second quarter. In June those were up to 2.2%

“It is that eternal triangle of the competitiveness of our growth, …. landing the pricing and managing the cost inflation,” Pitkethly said.

Chief Executive Alan Jope said the lag between the impact of commodity costs and the benefits of increased product prices had created “a higher than normal range of likely year end margin outcomes.”

Investec analyst Alicia Forry called the message on costs slightly disappointing.

“They had been confident of passing through cost inflation at the first quarter stage…now they change their tune.”

INFERNO BOOST

Half-year sales rose 5.4%, a touch above the 5.3% forecast, propelled by 8.1% growth in its Foods and Refreshment division, as living restrictions began to ease in many markets.

In Europe, sales of ice cream eaten out of home grew at double-digits, boosted by markets like Italy where its new Magnum lines honoring Dante – Inferno, Purgatorio and Paradiso – sold well. Sales of teas also saw strong volume growth.

Jope also said the company was “fully committed to staying in Israel” after the company was embroiled in a controversy earlier this week over its U.S. subsidiary Ben & Jerry’s move to end ice cream sales in occupied Palestinian territories that has caused a backlash against the brand in Israel.

Unilever also said it had completed the review of its tea business, and anticipates either an initial public offering, sale or partnership as a final outcome of the separation.

For a look at all of today’s economic events, check out our economic calendar.

($1 = 0.8476 euros)

($1 = 0.7276 pounds)

($1 = 0.7257 pounds)

(Reporting by Siddharth Cavale and Indranil Sarkar in Bengaluru; Editing by Tomasz Janowski and Keith Weir)

 

ECB Sees Some Risks to Outlook From Fresh Pandemic Wave

The Delta variant, a more contagious strand of the coronavirus, is becoming dominant in Europe, causing a resurgence of cases even in countries with relatively high vaccination rates.

The ECB still considers risks to the economy “broadly balanced”, Lagarde told a news conference, although the outlook continues to depend on the course of the pandemic and the progress of vaccination programmes across Europe.

“The reopening of large parts of the economy is supporting a vigorous bounce-back in the services sector. But the Delta variant of the coronavirus could dampen this recovery in services especially, in tourism and hospitality,” Lagarde said.

The ECB said at its June 10 meeting that it now saw risks to growth as “broadly balanced”, rather than tilted to the downside. Some policymakers even argued that the bank was underestimating how quickly the bloc would recover through the summer months as COVID-19 restrictions were lifted.

Lagarde said the ECB’s staff economic forecasts, unveiled at that June meeting, had included an assumption that some measures to contain the coronavirus would continue through the third and fourth quarters of 2021. Governments and citizens had become better able to cope with the pandemic during its successive waves, she added.

A fresh wave of coronavirus infections could potentially prolong the ECB’s emergency stimulus measures, which are due to end next March.

The ECB has long said that the 1.85 trillion euro Pandemic Emergency Purchase Programme will run as long as there is an emergency and with less than half of euro zone citizens fully vaccinated, the bloc appears especially at risk.

For a look at all of today’s economic events, check out our economic calendar.

(Reporting by Balazs Koranyi; Editing by Catherine Evans)

 

The Delta Variant Spreads. Will It Mutate Gold?

So, were you hoping that the epidemic was over? After all, millions of people got vaccinated, and the economy is booming. Restrictions have been generally lifted, the Fed removed the parts related to the pandemic from its monetary policy statement… why bother then?

The answer is: Delta. And I’m referring to the Sars-Cov-2 variant that causes Covid-19. As you know, viruses mutate from time to time as they spread and replicate. Delta is one of such mutations. Most mutations are not dangerous or even dumb (they weaken the viruses). But the problem with Delta is that it’s “the fastest and fittest” of all coronavirus variants, as the WHO described it. Just think about Rambo on steroids or a witcher that has just taken all his potions. Oh… Anyway, you got the point.

In particular, Delta is much more contagious than the original strain, and is spreading about twice as fast. A person infected with the classic version of the coronavirus can spread it to 2.5 other people, while a person with Delta can infect 3.5-4 other people. Delta might also be more severe and more lethal than the original strain.

The good news is that many people have been vaccinated and the vaccines (especially the mRNA-type) protect nicely against Delta. However, the bad news is that many people still haven’t gotten the shots, for many reasons. The tricky part here is that, given the high transmission rate of Delta, we would need 90% or even more people to be vaccinated to reach herd immunity, which is still a song of the future.

High transmissibility is the reason why Delta has become the dominant strain in the globe. It also increases the risk of further, potentially even more dangerous, mutations (more transmissions, more chances to evolve into Terminator). In other words, Delta’s fast transmission could reignite the pandemic. As the chart below shows, this is actually already happening.

As one can see, Delta reversed the trend of the declining number of new cases, spreading particularly quickly in the United Kingdom. But the U.S. Covid-19 cases also soared, surging 70% last week, while deaths went up 26%.

Implications for Gold

What do rising cases of Delta mean for gold? Well, I would say that Delta is fundamentally positive for gold and could mutate it into a more bullish strain. If the pandemic accelerates, governments may reintroduce some of the sanitary restrictions or even lockdowns. A new wave of the epidemic would also increase the chances of a big infrastructure bill in the US and other fiscal stimuli, while the Fed would likely remain dovish for longer than it would without Delta. So, inflation could intensify even further, while the real interest rates would drop. Therefore, concerned investors would turn to inflation hedges and safe havens such as gold.

However, what’s described above is the medium-term effects that Delta would cause if it triggered a new wave of cases and restrictions. In the short run, however, gold may decline, as worried investors would sell the assets and turn to the US dollar. This is what we saw in March 2020 but also on Monday (July 19, 2021). As the chart below shows, the London price of gold has declined, as the stronger greenback counterweighted the decline in the equities (Dow plunged more than 2%) and bond yields.

Furthermore, the next Great Lockdown is unlikely. Even if the government reintroduces some restrictions, their economic impact will be much smaller than during the earlier waves, as economies have adapted to operating under the epidemiological regime. Importantly, a new wave would be mainly limited to unvaccinated people, which would reduce the burden of health care systems and chances of hard lockdowns.

However, Monday’s equity selloff suggests a change in the market narrative. Investors have possibly realized that they had too optimistic expectations – economic growth may actually be slower than they thought. They have priced in a very strong recovery, which doesn’t have to materialize if a new pandemic wave hits the economy. Slower growth plus high inflation equals stagflation, gold’s favorite environment.

Having said that, it may take a while until gold rallies, as the end of reflation trade may also imply that some investors will sell commodities, including, to some extent, gold. Also, please note that the optimism and gains have quickly returned to the stock market, so the economic impact of Delta may be limited.

If you enjoyed today’s free gold report, we invite you to check out our premium services. We provide much more detailed fundamental analyses of the gold market in our monthly Gold Market Overview reports and we provide daily Gold & Silver Trading Alerts with clear buy and sell signals. In order to enjoy our gold analyses in their full scope, we invite you to subscribe today. If you’re not ready to subscribe yet though and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care

 

Italy, Spain Face Post-Pandemic Political Tests: Can EU Funds Ensure Near-Term Political Stability?

It is not clear. Italy is enjoying a rare phase of political calm while a reshuffled government of Spain may have engineered some momentary political stability of its own.

At the very least, Italy and Spain are examples of how euro-area governments are feeling their ways toward normalising budgetary policies after the Covid-19 crisis and addressing longer-term issues of sustainable growth vis-à-vis a mix of reform and use of EU recovery resources.

Sea change in Italy since Draghi’s rise to premiership

In Italy, there has been a sea change on the political end since February, with formation of the government of former ECB President Mario Draghi, who benefits from a strong absolute majority in parliament.

Draghi has accomplished some main objectives in his short time in office so far, namely accelerating the vaccination campaign and drafting the recovery programme.

Structural reform of Italy’s large and diversified economy remains paramount, all the same. Draghi needs to reconcile differing opinions of political groupings within his government – concerning judicial reform, competition policy and fiscal reform among other priority areas – in plans he aims to present later this month. Progress in ridding Italy of the bottlenecks that limit the nation’s growth potential is indeed vital.

A lengthier period under Draghi’s stewardship could be positive for Italy’s credit ratings

But how long will Draghi remain as head of government?

The current legislature ends in 2023, but early next year, Italian MPs elect the next Italian President.

Pre-pandemic, Draghi was the clear candidate to replacing President Sergio Mattarella in this role, in view of Draghi’s political stature and broad-based political support. Now the circumstances are less clear. One option is for Mattarella to seek a new term to allow Draghi to continue on as Prime Minister until 2023.

This could give Draghi the adequate time to oversee critical reforms and other measures to help ensure Italy achieves a more durable recovery while avoiding snap elections at this current critical juncture. A lengthier period of political stability in Italy would be considered as positive for Italy’s BBB+/Negative credit ratings.

Spain’s political situation remains challenging, though a temporary period of stability is possible pre-elections

In Spain, the political situation remains challenging, with a minority government of Prime Minister Pedro Sánchez’s Socialist Party and far-left Unidas Podemos (UP) facing a degree of instability after regional elections in Madrid, after which UP-head Pablo Iglesias resigned as Deputy Prime Minister.

Nonetheless, a potentially more encouraging development has been the government’s decision to partially pardon nine Catalan politicians and officials imprisoned after the illegal Catalan independence consultations of 2017. This move should facilitate more conciliatory relations between central and regional governments and ensure the Catalan pro-independence party, ERC, continues to support Spain’s central government in passage of critical legislation, most importantly the 2022 Budget.

These circumstances may lead to a temporary phase of political stability in Spain before elections due by December 2023.

EU Recovery funds support government stability and reform momentum

For Italy and Spain, the recovery and resilience programmes should support government stability and reform momentum over coming years. The large-scale EU funds allotted to the countries, with Italy and Spain being among main beneficiaries of EU funding, incentivise political groups to place differences aside for the moment to avoid stalling a fledgling recovery.

Simply reducing by half the gap between Italy’s and Spain’s respective performance compared with the strongest EU nations in terms of structural reform implementation would raise output by around 17% and 10% over 20 years, according to the European Commission. Leaving aside the social benefits, such growth would significantly help the countries manage elevated budget deficits and public debt.

On 16 July, the Agency I represent affirmed the ratings of Spain at A- and revised the Outlooks to Stable, from Negative. Our next scheduled sovereign credit review of Italy is on 20 August.

Giulia Branz is Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Powell Gave Congress Dovish Signs. Will It Help Gold?

Last week, Powell testified before Congress. On the one hand, Powell admitted in a way that inflation had reached a level higher than expected and is above the level accepted by the Fed in the longer run:

Inflation has increased notably and will likely remain elevated in coming months before moderating.

It means that the Fed was surprised by high inflation, but it doesn’t want to admit it explicitly. Instead, Powell admitted that inflation would likely stay at a high level for some time. The obvious question here is: why should we believe the Fed that inflation will really moderate later this year, given that the US central bank failed in forecasting inflation in the first half of 2021?

What’s more, Powell acknowledged that he hasn’t felt comfortable with the current level of inflation:

Right now, inflation is not moderately above 2%; it is well above 2%. The question is, where does it leave us six months from now? It depends on the path of the economy.

It means that, at some point in the future, if high inflation turns out to be more persistent than expected, the Fed will act to bring inflation back to lower levels. However, nobody knows when exactly it could happen – and I bet that, for political reasons, it would happen rather later than sooner.

Indeed, even though inflation turned out to be higher than previously thought, Powell downplayed the danger of rising prices, reiterating the view that inflation is transitory. In particular, Powell maintained that recent price hikes were closely related to the post-pandemic recovery and would fade after some time:

The high inflation readings are for a small group of goods and services directly tied to reopening.

I dare to disagree. It’s true that the hike in the index for used cars accounted for one-third of the June CPI jump. But two-thirds of 5.4% is 3.6%, still much above the Fed’s target! Anyway, in line with its narrative, the Fed doesn’t see a need to rush with its tightening cycle. After all, the US labor market is – according to Powell and his colleagues from the FOMC – still far from achieving “substantial further progress”, with 7.5 million jobs missing from the level seen before the start of the pandemic. So, the tapering of quantitative easing is – as Powell noted – “still a ways off”. So, overall, Powell’s remarks were dovish and positive for the yellow metal.

Implications for Gold

What does Powell’s recent testimony imply for the gold market? Well, the yellow metal initially rose after his appearance in Congress. This is probably because investors bought the narrative about transitory inflation and decided that monetary taps would stay open for a long time and tapering would start later than investors expected in the aftermath of the recent dot-plot. The rising cases of the Delta variant of the coronavirus is another reason why investors could bet that the Fed would maintain its accommodative monetary policy. So, the bond yields declined, while the price of gold increased as the chart below shows.

However, gold’s reaction was disappointingly soft given the dovishness of Powell’s remarks, and the yellow metal declined again later last week amid some better-than-expected economic data. It seems that there is hesitancy among precious metals investors about whether or not to take a more decisive step with purchases of gold. The reason is probably that, sooner or later, the interest rates will have to rise in response to inflation. It means that the opportunity costs of holding gold will increase, exerting some downward pressure on gold.

Nevertheless, the real interest rates should remain low, so gold prices shouldn’t drop like a stone. Actually, in the longer run, when inflation creates some economic problems while the economic growth slows down, the yellow metal could finally benefit from the stagflationary conditions.

If you enjoyed today’s free gold report, we invite you to check out our premium services. We provide much more detailed fundamental analyses of the gold market in our monthly Gold Market Overview reports and we provide daily Gold & Silver Trading Alerts with clear buy and sell signals. In order to enjoy our gold analyses in their full scope, we invite you to subscribe today. If you’re not ready to subscribe yet though and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care

Precious Metals Seek Direction Amid Rising Delta Variant Concerns

Many countries in Asia and Europe are struggling to curb the highly contagious Delta variant of the coronavirus and have been forced into taking lockdown measures. The spread of the Delta variant has prompted concerns that the global economic recovery could be derailed.

Elsewhere, the annual rate of U.S Inflation accelerated from 5.0% to 5.4% in June – the highest on record since 2008. While the core annual rate of inflation rose from 3.8% to 4.5%. Many economist now forecast that Inflation in the U.S will climb to between 6% and 9% by year-end.

Looking ahead to this week, the major market-moving event that traders will be closely watching is the European Central Banks monetary policy meeting.

The meeting should shed more light on whether the ECB’s new strategy is just window-dressing or an actual shift towards a more dovishness monetary policy stance to achieve what the ECB hasn’t achieved for a decade – which is getting inflation back under control.

The EBC meeting takes place one week ahead of the Federal Reserve’s July monetary policy meeting, which is also likely to be dominated by the narrative of surging inflation.

Other key macro events include: U.S. jobless claims data and U.S. manufacturing PMI data.

Where are prices heading next? Watch The Commodity Report now, for my latest price forecasts and predictions:

Us Consumer Prices Surge Above Expectations in June – Transitory Rise or Inflation Is Unleashed

The consumer price index rose by 0.9% in June from 0.6% in May, beating the forecast of 0.5% increase, while the inflation in the twelve months through June jumped 5.4% – the highest in thirteen years – after rising 5.0% in May, overshooting the 4.9% forecast.

The so-called core CPI which excludes volatile food and energy components, rose by 4.5% on a year-on-year basis from the 3.8% increase in May, making the biggest increase since November 1991.

Strong rebound in the costs of travel-related services and persisting supply constraints were the main drivers of inflation last month, as the low interest rates and the nearly $6 trillion that the government has pumped into the economy since the pandemic started in the United States, fueled the demand and strained the supply chain that lifted prices across the economy.

Although the inflation in the US has likely peaked, it is expected to remain elevated through the second half of 2021 and a part of 2022, as demand for travel and accommodation services continues to rise and prices for most of these services are still below pre-pandemic levels.

The US Federal Reserve has repeatedly stated that the higher inflation will be transitory, and the central bank could tolerate higher consumer prices for some time, to offset years in which inflation stayed well below its 2% target.

On the other side, a number of policymakers see inflation risks shifted to the upside and the Fed needs to be prepared to act if those risks materialize, as many fear that the mix of monetary and stimulus measures has gone too far and could spark uncontrollable inflation.

The fresh spread of the Covid-19 virus with the Delta variant in the US threatens to slow the economic recovery if new cases continue to rise quickly, but new restrictive measures are unnecessary to cool down the inflation.

With current inflation being well above the 2% target, the main question for the Federal Open Market Committee will be where the consumer prices will stand in six months.

The US policymakers reiterated that the central bank would use all available tools to guide the inflation back down but remain convinced that the recent price hikes are transitory and associated with the post-pandemic reopening of the economy.

The Federal Reserve Chairman Jerome Powell, in his testimony to the US House of Representatives, repeated this view, expressing expectations that inflation pressures will fade and that the central bank should stay focused on getting back to work as many people as possible, as the US labor market is still short around 7.5 million jobs, compared to the pre-pandemic period.

Powell said that the current high inflation readings are for a small group of goods and services directly tied to the reopening of the economy, seeing no need to rush with the start of changing the policy from the ultra-loose mode, introduced during the crisis, towards a post-pandemic gradual tightening.

The central bank is expected to continue to closely watch the situation and to pump money into the economy until the Fed’s second key requirement for starting to tighten the policy – substantial further progress in the labor market – is reached, with interest rates expected to stay near zero until at least 2023.

But the recent surge in consumer prices has divided the US politicians and lawmakers, with Democrats urging the Fed not to slow the recovery with too-early policy action, while Republicans worry that the central bank’s response to the surging inflation might be too slow.

Republican representatives point to a strong rise in prices that already hurt businesses and families and sideline the Fed’s description for price increases is temporary. They also questioned Powell about a new framework that aims to encourage higher employment by keeping inflation to run moderately above the Fed’s 2% target for some time, as higher inflation starts to bite, and it is unclear how long that ‘some time’ will last.

The Fed is also pressured by signals from several major central banks that started their policy tightening due to a strong rise in inflation earlier than expected.

The main question is whether the current surge in prices is temporary, as US policymakers see it, and the reduction of the financial stimulus and an increase of interest rates can wait, or the sharp rise signals that inflation is getting off its leash and the US central bank might be late to react on such a scenario.

China’s Economic Outlook Stabilises as Beijing Addresses Financial Risks to Enhance Resilience

The Chinese state’s commitment to reining in credit growth, deflating asset bubbles, and cutting off state support for unproductive firms while also encouraging the development of Chinese financial markets and opening the capital account support the sustainability of China’s growth model.

Reduced financial-stability risk is partially a function of a noticeably reduced concentration of the state on meeting inflated ‘hard’ growth objectives. The latest Five-Year Plan target of doubling the size of the economy between 2020 and 2035 implies a more manageable average annual growth of 4.5% over 2022-35 assuming growth in GDP of 8.6% (our updated forecast) this year.

Such structural reforms ease still significant economy-wide debt risks and increase likelihood of a ‘soft’ rather than ‘hard’ landing after the significant private- and public-sector debt accumulated since the global financial crisis. As economic growth recovered slightly to 1.3% Q/Q in the second quarter, we expect Chinese authorities to balance management of financial stability risk with a parallel need to support recovery over the second half of this year.

Trend growth of China’s economy still compares favorably with that of most economies

Even as growth cooled since the initial rebound from Q1 2020 troughs, trend growth of China’s large and diversified economy remains very high compared with that of most economies around the world even if the former moderates towards a 5% rate over the medium run.

The Agency I represent affirmed China’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at A+ on 9 July and revised the Outlooks to Stable from Negative. We also affirmed China’s short-term issuer ratings at S-1+ in local- and foreign-currency and revised the Outlooks to Stable from Negative.

Extensive financial-stability reform and progress of renminbi as reserve currency underscore improved outlook

Extensive supervisory and regulatory changes have intensified since the Covid-19 economic crisis with the People’s Bank of China laying out defined priorities in the period to 2025 that include improvement of the macro-prudential assessment framework and strengthening supervision of systemically important institutions, businesses and infrastructure.

Further anchoring China’s improved outlook is gradual progress in establishing the renminbi as a global reserve currency, which in turn reinforces the country’s economic resilience on top of existing external-sector buffers relating to high foreign-exchange reserves and low external debt.

Budget deficits and rising public debt remain credit challenges

Structural public-sector fiscal deficits as well as an increasing public-sector debt stock over the long run remain prevailing credit challenges, exacerbated by the fiscal and monetary easing adopted to cushion China’s economy against repeated macroeconomic shocks.

China’s general government deficit increased to 11.4% of GDP in 2020 despite relatively moderate pandemic-related fiscal stimulus, from 6.3% in 2019 and only 0.9% of GDP in 2014. The general government deficit will remain a sizeable 9.5% of GDP this year before narrowing to 8.6% next year.

High and rising levels of total non-financial sector debt since 2008 remain a core credit challenge, although authorities have taken important steps to easing this trajectory of rising debt.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Gold Asks: Has Inflation Already Peaked?

Inflation has soared recently. The CPI annual rate surged 5% in May, which was the fastest jump since the Great Recession. However, the Fed officials still maintain that inflation will only be temporary. Some of the analysts even claim that inflation has already peaked, and it will decelerate from now on. Are they right?

Well, they present a few strong arguments. First, there is no doubt that the recent rise in prices has been partially caused by the problems with the supply chains. But, luckily, the bottlenecks are short-lived phenomena, and they always resolve themselves, i.e., by the magic of market mechanism. The best example may be lumber prices which were skyrocketing earlier this year but which have recently declined, as production surged in response to rallying prices.

Second, the detailed data on inflation shows that the surge in the overall inflation index was partially driven by categories that were heavily distorted by the pandemic, such as used cars or airline fares. The increases in these categories are not surprising or worrying, given the current recovery from the epidemic.

Third, the market-based inflation expectations have already peaked. As the chart below shows, both 5-year and 10-year breakeven inflation rates have reached their heights in May. Since then, the former ones have declined from above 2.7% to about 2.3%, while the latter from above 2.5% to about 2.2%

It means that the markets bought the Fed’s narrative about temporary inflation and started to worry less about it.

Should gold investors do the same? I’m not so sure. To be clear, I acknowledge and always acknowledged that the supply problems contributed to the acceleration in inflation. However, the risk of inflation doesn’t solely depend on continuously rising commodity prices. And the Fed officials always say that increases in inflation rates are temporary, as they don’t want to admit they failed in maintaining price stability.

Some fundamental factors supporting high inflation are still in force. First, as the chart below shows, the broad money supply is still increasing fast (although there was a deceleration since February), as the monetary impulses probably haven’t been fully transmitted into the real economy yet.

Second, both the monetary and fiscal policies remain very easy. Given President Biden’s fiscal agenda and the continuous increase in the public debt, the Fed is unlikely to materially normalize its monetary policy.

Third, we know that in response to input cost inflation, producers raised their charges at an unprecedented pace. It means that their power to pass on greater costs has increased, which could increase both inflation and consumers’ expectations of inflation in the future.

Fourth, we have just finished recovering from the economic crisis. Usually, inflationary pressures only intensify with the progress of the business cycle. With a developing and then maturing economic expansion, employment will rise, manufacturing capacity will be more fully utilized, and inflation could prove to be more persistent than anticipated by the pundits. Please remember that the fiscal stimulus the economy got was greater than the estimated size of the output gap, so the risk of overheating is still present, even if some bottlenecks have resolved.

Last but not least, the rise in inflation wasn’t driven solely by the recovery from the pandemic. Some categories which were severely hit by the epidemic are not surging. For example, the index for food away from home rose annually by 4% in May 2021. Meanwhile, some core components surged. For instance, the index for shelter, which makes almost one-third of the overall index, increased from 1.5% in February to 2.2% in May 2021, as the chart below shows. It suggests that inflation may be more broad-based than many analysts think.

What does all this mean for the gold market? Well, if inflation remains high or even continues to rise, the real interest rates will remain in negative territory, supporting gold prices. However, there is an important caveat: upward inflationary surprises could force the Fed to send fresh hawkish messages or even taper its quantitative easing earlier than planned, pushing the nominal bond yields higher and creating selling pressure on gold prices.

It seems that so far investors were more worried by the sooner-than-expected hikes in the federal funds rate than by the rising inflation and the fact that the FOMC members have raised their inflation forecasts by an entire percentage point. Gold bulls need a shift in investors’ focus. Otherwise, the markets could remain optimistic about the future, purchasing risky assets rather than safe havens such as gold.

Thank you for reading today’s free analysis. We hope you enjoyed it. If so, we would like to invite you to sign up for our free gold newsletter. Once you sign up, you’ll also get 7-day no-obligation trial of all our premium gold services, including our Gold & Silver Trading Alerts. Sign up today!

Arkadiusz Sieron, PhD
Sunshine Profits: Effective Investment through Diligence & Care.

 

Dollar Ends Week Strong on Upbeat U.S. Retail Sales Data

The dollar index, which measures the greenback against a basket of six currencies, was 0.11% higher at 92.675. The index is up 0.6% for the week.

U.S. retail sales unexpectedly increased in June as demand for goods remained strong even as spending was shifting back to services.

A survey that showed U.S. consumer sentiment fell sharply and unexpectedly in early July to the lowest level in five months, as inflation worries dented confidence in the economic recovery, did little to dent the dollar’s stronger tone.

Solid U.S. data and a shift in interest rate expectations after the Federal Reserve flagged in June sooner-than-expected hikes in 2023 have helped lift the dollar in recent weeks and made investors nervous about shorting it.

Friday’s gains for the dollar came despite Fed Chair Jerome Powell reiterating on Thursday that rising inflation was likely to be transitory and that the U.S. central bank would continue to support the economy.

“The data was consistent with the economy making substantial strides and cements expectations of very robust second quarter growth of around 10%,” said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.

“A backdrop of rising inflation, falling unemployment and a resilient consumer makes a compelling case for the Fed to unwind stimulus,” Manimbo said.

The New Zealand dollar gained 0.44% after data showed New Zealand’s consumer prices rose far faster than expected, prompting some in the market to bet on a rate hike as soon as August..

Sterling fell against the dollar, on pace for its worst week in a month, as investors sought safety in the greenback amid concerns over rising COVID-19 cases globally.

The Canadian dollar climbed 0.1% on Friday, helped by upbeat domestic wholesale trade data, a day after touching a near 3-month low against its U.S. counterpart.

Cryptocurrencies found support after recent turbulence, with bitcoin about flat on the day at $32,027.33.

For a look at all of today’s economic events, check out our economic calendar.

(Reporting by Saqib Iqbal Ahmed and Iain Withers, Additional reporting by Tom Westbrook in Singapore; Editing by Steve Orlofsky, Mark Heinrich and Alex Richardson)

Take Five: ECB, earnings galore and ‘Freedom Day’

1/ ECB DAY

Two weeks after unveiling its closely anticipated strategy review, the ECB will face questions at its Thursday meeting on what its new 2% inflation target might mean for policy.

If the ECB is serious about boosting inflation to 2% (versus close to but below 2% before), surely hefty bond buying will continue for some time? Doves are already arguing that to remain credible, the ECB needs to highlight its room for manoeuvre.

The hawks though are already pressing for tapering stimulus as the economy rebounds. Perhaps concern about a resurgent coronavirus hurting growth will allow ECB chief Christine Lagarde to find common ground at Thursday’s meeting. A quiet summer may be around the corner for most, not the ECB.

2/ OUTLIER

Many developed economies are pondering tapering emergency stimulus but China has just added more money to its banking system and there’s an outside chance the benchmark loan prime rate (LPR) set by Chinese banks could be lowered as early as Tuesday.

The dual-track economy is seeing supply-side headwinds, growth and exports are peaking, while consumer spending flags. An uncertain regulatory environment for big firms and standoffs with the United States are weighing on investor sentiment.

After the recent cut to banks’ reserve requirements and data showing the economy lost some steam in the second quarter, markets expect a bit of monetary easing even as fiscal policy stays tight.

3/ FIRST FAANG

The second-quarter U.S. earnings season kicked off with stronger-than-expected numbers from banks, now it’s the turn of the tech and consumer giants, including streaming heavyweight Netflix.

A darling of last year’s stay-at-home trade, Netflix shares are up just 2% this year as investors have shifted to stocks which benefit as the economy reopens. Lower production of TV shows and movies during COVID-19 have dented subscriber growth.

Signs U.S. economic growth has peaked have nevertheless been boosting the tech stocks that led markets for much of the past decade so Netflix shares too have rallied of late.

The coming days also see quarterly results from the likes of Johnson & Johnson, Coca-Cola, Twitter and Intel.

4/ AS GOOD AS IT GETS?

Europe’s results season is starting in earnest, meanwhile, and corporate earnings are expected to have more than doubled in Q2.

Profits of the 600 biggest listed European companies are seen surging 110% between April and June, according to Refinitiv I/B/E/S data.

Yet investors fear this is as good as it will get and that volatility could follow once peak momentum is hit – earnings growth rates of roughly 34% and 28% are expected for the last two quarters of 2021.

There is also the COVID-19 upsurge to contend with. Bourses in Europe, as on Wall Street, are near record highs but any risk of renewed lockdowns could easily knock them off that perch.

5/ FREEDOM OR RISK

The British media dubs it “Freedom Day,” Germany describes it as a “highly risky experiment”. So, who’s right about July 19, the day Britain drops its COVID-19-linked activity curbs and mandatory mask-wearing?

Britain’s blistering vaccine campaign had made the pound one of this year’s best performing G10 currencies, lifted shares in UK hospitality and retail firms and spurred hopes of a swift economic rebound.

But an upsurge in the Delta variant and forecasts for Britain’s COVID caseload to reach 100,000 a day by the end of August are stirring unease. Bonds are benefiting from a rush to safety while European travel shares are down 8% in the past month.

Friday’s July Purchasing Managers’ Index releases may reflect the impact of rising infections on activity. With the likes of Israel and Holland backtracking on reopening plans and Germany retaining curbs until vaccinations rise, just how long Britons enjoy their freedom from lockdown remains to be seen.

(Reporting by Lewis Krauskopf in New York, Vidya Ranganathan in Singapore, Sujata Rao, Julien Ponthus and Dhara Ranasinghe in London; Compiled by Dhara Ranasinghe; Editing by Catherine Evans)

 

Is FED Playing Cat and Mouse with Investors?

You Don’t Say!

At first it was nothing, then it was something, and now it’s…

Source: CNBC

Speaking with CNBC on Jul. 15, U.S. Treasury Secretary Janet Yellen – who preceded Jerome Powell as the Chairman of the U.S. Federal Reserve (FED) – said that declining long-term Treasury yields is “the market expressing its views that inflation does remain under control.” However, while the contradictory statements of “several more months of rapid inflation” and “inflation does remain under control” are quite humorous, she has a point: with bond investors eager to front-run the FED’s forthcoming taper, the U.S. 10-Year Treasury yield has been the main casualty. And with gold often moving inversely of the U.S. 10-Year real yield, the development has strengthened the yellow metal.

Please see below:

To explain, the gold line above tracks the London Bullion Market Association (LBMA) Gold Price, while the red line above tracks the inverted U.S. 10-Year real yield. For context, inverted means that the latter’s scale is flipped upside down and that a rising red line represents a falling U.S. 10-Year real yield, while a falling red line represents a rising U.S. 10-Year real yield.

If you analyze the relationship, you can see that one’s pain is often the other one’s gain. And if you focus your attention on the right side of the chart, you can see that the U.S. 10-Year real yield’s recent malaise has uplifted the yellow metal.

Despite that, while Powell and Yellen continue to make excuses for their lack of foresight, Powell actually told Congress on Jul. 15 that surging inflation caught ‘everyone’ by surprise.

Please see below:

Source: CNBC

However, while I’ve been warning for months that inflation was likely to boil, both policymakers are underestimating the lasting effects. And in the process, bond investors have buried their heads in the sand. Conversely, while “temporary” and “transitory” remain Powell’s favorite buzzwords, supply chain disruptions still haven’t fully filtered into the core Consumer Price Index (CPI).

Please see below:

Source: Robin Brooks/Institute of International Finance (IIF)

To explain, the chart on the left depicts the effect of supplier delivery times on the core Producer Price Index (PPI). If you analyze the relationship, you can see that the red and light blue lines are roughly three standard deviations above their historical average (follow the scales on the right side of both charts). Conversely, if you analyze the chart on the right, you can see that the core CPI (the light blue line) is still less than two standard deviations above its historical average. As a result, the core CPI still hasn’t felt the brunt of the inflationary surge.

What’s more, the New York FED released its Empire State Manufacturing Survey on Jul. 15. And with one header reading “Selling Prices Increase at Record-Setting Pace,” cost-push inflation remains alive and well.

Please see below:

Source: NY FED

In addition, New York’s’ manufacturing sector expanded rapidly and supply chain disruptions (delivery times) remain an issue. An excerpt from the report read:

Business activity grew at a record-setting pace in New York State, The headline general business conditions index shot up twenty-six points to 43.0. New orders and shipments increased robustly. Delivery times continued to lengthen substantially, and inventories expanded. Employment grew strongly, and the average workweek increased. Input prices continued to increase sharply, and selling prices rose at the fastest pace on record. Looking ahead, firms remained optimistic that conditions would improve over the next six months, with the index for future employment reaching another record high.”

Turning to the second major player in gold’s bearish forecast, the USD Index is hitting its stride. And as sentiment shifts, the U.S. dollar is gaining significant support from speculators.

Please see below:

To explain, the dark blue, gray and light blue lines above represent net-long positions of non-commercial (speculative) futures traders, asset managers and leveraged funds. When the lines are falling, it means that the trio have reduced their net-long positions and are expecting a weaker U.S. dollar. Conversely, when the lines are rising, it means that the trio have increased their net-long positions and are expecting a stronger U.S. dollar. And if you analyze the right side of the chart, you can see that non-commercial futures traders and asset managers have completely changed their tune (though leveraged funds’ movement has been minimal).

On top of that, the latest USD Outlook from Vanda Research offers an interesting take on the FED’s forthcoming taper. Predicting that a ‘buy the rumor, sell the news’ event will unfold over the next several weeks, the firm believes that speculators will likely front-run the expected announcement.

Please see below:

To explain, if you analyze the first chart on the left, the pink bars (two months before), the dark blue bars (actual event) and the light blue bars (two months after) depict speculators’ USD positioning before, during and after hawkish FED announcements. And if you analyze the relationship, more often than not, speculators buy the U.S. dollar in anticipation, hold throughout the event and then bail after the drama unfolds.

As further evidence, if you turn to the chart on the right, you can see that leveraged funds are notorious for front-running the FED’s actions. With eight weeks preceding major FED events often resulting in significant increases in net-long positioning, leveraged funds aim to strike while the iron is hot. The bottom line? With the Jackson Hole Economic Policy Symposium scheduled for Aug. 26-28 (roughly six weeks away), another front-run could already be underway.

Finally, while I’ve been warning for some time that the FED’s daily reverse repurchase agreements are the fundamental equivalent of a shadow taper (though, it doesn’t have the same psychological effect), the FED sold $776.261 billion worth of reverse repos on Jul. 15 and $859.975 billion worth of reverse repos on Jul. 14. More importantly, though, with the U.S. 10-Year Treasury yield often moving inversely of the FED’s international reverse repos, bond investors are behaving as if the taper is already underway.

Please see below:

To explain, the dark blue line above tracks the quarterly percentage change in the U.S. 10-Year Treasury yield, while the light blue line above tracks the FED’s inverted (scale flipped upside down) international reverse repos. If you analyze the relationship, you can see that the larger the liquidity drain, the more bond investors position for slower growth, lower inflation and a hawkish FED.

Conversely, the dynamic has the opposite effect on the USD Index. With U.S. dollars being siphoned out of the system, it’s akin to the FED reducing its QE program. As such, the liquidity drain (lower supply of dollars) is extremely bullish for the greenback.

In conclusion, while the PMs have been buoyed by falling real yields, their relative performance has been extremely subdued. From March through May, gold rallied sharply once the U.S. 10-Year real yield reversed course. This time around, however, the bounce has been tepid, as concerns over a prospective taper counters the bullish optimism. As a result, with the USD Index gaining steam, inflation surging and a taper announcement likely to commence in September, the PMs’ optimism could evaporate at the drop of a dime. Thus, it’s prudent to avoid reading too much into their recent strength.

Thank you for reading our free analysis today. Please note that the above is just a small fraction of today’s all-encompassing Gold & Silver Trading Alert. The latter includes multiple premium details such as the targets for gold and mining stocks that could be reached in the next few weeks. If you’d like to read those premium details, we have good news for you. As soon as you sign up for our free gold newsletter, you’ll get a free 7-day no-obligation trial access to our premium Gold & Silver Trading Alerts. It’s really free – sign up today.

For a look at all of today’s economic events, check out our economic calendar.

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Sunshine Profits: Effective Investment through Diligence & Care

* * * * *

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits’ associates only. As such, it may prove wrong and be subject to change without notice. Opinions and analyses are based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are deemed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski’s, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits’ employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.