LAWRIE WILLIAMS: All fall down – except the dollar.
The past week certainly ended in disappointment for investors in precious metals, equities and bitcoin, all of which saw big falls in price as the week drew to a close and opened weaker still in Asia and Europe this morning. The downturn appeared to be precipitated by market fears in the U.S. that the Fed might be about to ‘overtighten’ at the early May Federal Open Market Committee (FOMC) meeting due to take place on May 3rd and 4th, potentially leading to at best a mini-recession.
Quite why precious metals prices were so badly affected puzzles us – we might have speculated that this kind of negative equity price movement could even have seen them rise. However the likely above average interest rate rise scenario so envisaged did see an increase in the U.S. dollar index (USDX) = which values the dollar against other world currencies - and there is always a tendency for gold, in particular, to fall when the dollar rises, and vice versa, with the other precious metals following suit.
It is the inflation ‘big bad wolf’ which is causing the price mayhem. The Consumer Price Index (CPI) came in at a massive 8.5% increase year on year earlier in the month and the Producer Price Index (PPI) which perhaps even better reflects the prices actually being received by suppliers at an even more worrying 11.2% year on year. There are worries that these figures may still be rising so the April data releases are being awaited with some degree of trepidation.
The next significant inflation data release is due out on Friday this week and is the Personal Consumption Expenditure Index (PCE) which is the Fed’s preferred inflation measure, and tends to come in a couple of percentage points lower than the CPI. The last PCE data announcement showed this measure of inflation rising at 6.4% year on year, but this, like the other inflation data was at its highest level for more than 40 years. Indeed if the data was still being calculated in the manner it was 40 years ago, all these inflation figures would actually be far higher. John Williams’s ShadowStats service which calculates U.S. government data the way it was in the past before it was manipulated lower in order to justify reducing social security payments among other things, puts the current CPI at approaching 20% - a level that would perhaps be more attuned to the experience of the person in the street.
What has to be particularly worrying for the Powell Fed is that when the inflation rate strayed into double digits just over 40 years ago, the remedy from then Fed chair Paul Volcker was to implement moves taking U.S. interest rates to around 20% and thereby precipitate a very severe recession. This ultimately had the effect of defeating inflation and setting the U.S. economy on an upwards path that has run now for decades. There’s no way Powell can do this, given the enormous cost of servicing the nation’s enormous debt level (estimated at over $30.4 trillion or around 125% of the nation’s GDP) built up over the past several years, at higher interest rate levels!
The kind of interest rate rises available to the Fed without disturbing the U.S.’s continuing economic growth are thus extremely limited, and if the Fed’s judgment on this is wrong it could precipitate either a recession if its inevitable rate increases are seen as being too high by the markets, or continuing runaway inflation if rises are too low. This is a very fine balancing act and we would rate the Fed’s chances of getting it right at probably 50:50 or less. And even if it can raise rates slow enough so as not to spook the markets, any inflation reduction will likely take an inordinate amount of time – maybe a couple of years or more to come back to the Fed’s target 2% rate. A marginal miscalculation either way could put the whole process in jeopardy, and let’s face it the Fed does not have a great record on economic forecasting to date.