LAWRIE WILLIAMS: Another high inflation reading brings little change
The latest inflation data reading, the Fed’s preferred measure, the Personal Consumption Expenditure Index (PCE) for June, offered little or no respite from the string of adverse data which came in earlier in the month. It too came in well above analyst expectations at the highest level in 40 years at +6.8% year on year, a half-point higher than the +6.3% expected and only 10 basis points off the all-time high set in 1982. Hopes that it might begin to show a flattening of the inflation curve were thus again dashed.
The string of high inflation data suggests that the U.S. economy is very definitely headed for recession. This is contrary to denials from President Biden and Fed chair Powell who both have other reasons for putting a more positive spin on the reality. The next few weeks are likely to see them backpedal on their perhaps over-optimistic forecasts, or at least temper them.
Despite the seemingly adverse figures, equities and bitcoin continued to show some strength – foolishly in our opinion - but gold and silver also benefited with rather more reason we feel. Indeed the U.S. economy is already almost certainly in a technical recession with the latest Bureau of Economic Activity preliminary Q2 GDP figures suggesting a second successive quarterly downturn of -0.9% following a -1.4% contraction in Q1. Two successive negative quarterly GDP reads are perhaps the standard definition of a recession!
A recession should see equities decline. Discretionary expenditure falls as budgets tighten. Inflation sees prices rise, wages struggle to keep up, unemployment tends to rise and profit margins fall. We are already seeing reports of a fall-off in discretionary non-essential subscriptions in the service sector and household budgets are being squeezed through rising food and energy prices in particular. This is already beginning to filter through to profit margins and will result in growing small business failures. In short, recessionary trends will soon begin to affect bottom lines across the board and it cannot be long before business profit margins, and thus equity prices, begin to suffer. Once a downturn begins it could become something of a rout.
Bitcoin could also suffer quite dramatically too. Bitcoin value growth depends almost wholly on investor confidence. If this starts falling away for other risk-on asset classes it could well affect bitcoin too. We would not be at all surprised to see bitcoin come back at least another 50% or more amidst a general equity crash of around the same magnitude.
All this brings us back to precious metals. Gold in particular tends to perform relatively well in a recession, as incidentally do gold equities. It is seen as something of a wealth protector under adverse economic conditions, and silver – even if it is not quite so relevant as such – tends to follow suit, more by tradition than justification. But be a bit more wary of the pgms. They are very much industrial metals nowadays and although they may still have minor demand in the monetary and jewellery sectors they are far more dependent on the motor vehicle market for their demand and this sector may be one of the first to suffer from discretionary expenditure cutbacks during a recession.
Precious metals, equities and bitcoin prices opened the new week in Asian and early European markets pretty much flat with equities slightly up and precious metals and bitcoin a tad weaker, but neither significantly so. We will have to wait for U.S. markets to open later in the day to see if there is any real directional influence. If there is we would anticipate a degree of equity and bitcoin weakness on further recession fears, but markets always have a tendency to be over-optimistic until they reverse – sometimes rapidly. Beware.