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LAWRIE WILLIAMS: Fedwatch predictions see aggressive interest rate approach easing

Thursday’s big improvement in the predicted level of Q3 U.S. GDP, coupled with Friday’s smaller than predicted rise in the Personal Consumption Expenditure (PCE) core inflation data from the Bureau of Economic Analysis, provided quite a sentiment game-changer in the eyes of the U.S. investment community.  The figures have, at least to an extent, partly justified recent equity price rises, although the somewhat erratic influence on the U.S. dollar index and precious metals prices is not so easy to comprehend.  However the overall direction of the economy suggested by the latest figures may not be as predictable in their consequences as some would be drawn to believe.

Let us look first at equity prices.  All the major indexes saw rises over the past couple of weeks, although yesterday we saw the strange phenomenon of the Dow rising while the NASDAQ and S&P 500 were both falling back at one time, although all were recording decent gains by the close of business.  Asian stocks fell overnight after gains the day before and European stocks were trending down.  Cryptocurrencies, as exemplified by bitcoin and ethereum, which had been having a strong week, were somewhat mixed in direction

In precious metals, gold and silver both ended the day comfortably in negative territory as the USDX regained a little of the ground it had lost earlier in the week, although remaining well below its recent high point.  But even so they both managed to remain well above their earlier lows.  As for the pgms, the price gap between platinum and palladium closed quite substantially, but they still remained nearly $900 apart.  We predicted last year that they might reach parity.  They still have a long way to go before that could happen but the longer term prospects for Pt are, to our minds, rather better than for Pd, although the Russia/Ukraine war has brought another contributory element into that equation given the former country’s dominance in global Pd production.

But the big impact of the latest U.S. data seems to have been on investment sentiment.  The odds on the aggressive rates of likely Fed rate increase impositions at forthcoming FOMC meetings have been coming down sharply according to the Chicago Mercantile Exchange’s Fedwatch Tool which categorises the investment professionals’ views on the Fed’s likely interest rate moves.  Even the odds on the likely 75 basis point (3/4%) interest rate rise at the November 1-2 meeting, now only a few days away, have come down from a near 100% certainty to around 82%.  Further the Fedwatch Tool had been predicting another similar 75 basis point increase in December – the fifth in a row - but is now only suggesting a 50 basis point rise rather than a 75 point one by odds of 48.2:43.4 with 8.4% favouring an even smaller 25 basis point increment.

There is thus something of an air of economic optimism permeating the markets.  Things are not looking as bad as the doom and gloom merchants had been predicting. The recession-deniers, who include President Biden and Fed chair Powell, have something to shout about – the former in particular with the mid-term elections imminent.  Perhaps a soft landing is now looking more likely?  However, the fact that inflation is still rising, despite the Fed’s aggressive actions to date, has to be worrying given Fed chair Powell’s adamant past statements that the Fed will do what it has to in order to bring it back down.  Maybe the market euphoria is somewhat unjustified!

There are certainly still those who would urge caution.  The U.S. economy is almost certainly not out of the woods yet.  Inflation remains at a much higher level than the Fed would like and the prospective Q3 GDP figures may also prove to be an anomaly, the latest increase having been so dependent on foreign trade figures which are now projected to decline, the difference quite possibly contributing to tipping the U.S. economy into recession again by next year, if not earlier.  Export earnings are being boosted by energy sales to gas-starved European nations, but are also vulnerable to a higher dollar. 

The strong dollar will thus have been having a hugely negative effect on the price competitiveness of other U.S. exports though, while import prices will become more attractive thus adversely affecting the current account balance.  High export earnings and low import levels had both been hugely significant contributors to the Q3 GDP assessment.

Meanwhile inflation will be eating ever further into household expenditures, and falling property prices will contribute to a feeling of a reduction in wealth which will curtail outgoings.  In combination this will likely lead to a downturn in GDP in Q4 and in 2023 and beyond depending on how long the inflationary pressures continue.  There is no sign yet that they may be coming down.  The Fed’s target inflation level of 2% looks completely unattainable and may well be increased to a more achievable 3-4% for the next year or so.  The U.S. public is probably going to have to live with higher inflation levels for the time being,

Credit card debt has been on the rise quite severely, but again as interest rates rise this becomes ever less affordable.  Defaults will increase.  The future for the American person-in-the-street weaned on almost unlimited credit does not look to be a pretty one.  And the same prospect faces us all to a greater or lesser extent throughout the so-called developed world, raised as we have been on the American propensity to live our lives on credit.  This is all very well when income is steady and tending to advance, but not a good recipe for surviving a recession with incomes and property prices declining and retail prices and unemployment rising. 

As recession looms, in the U.S. and globally, the Fed will thus be under intense pressure to mitigate its aggressive interest rate policy and one suspects this will become apparent in the FOMC discussions this time around and at future meetings.  Ever-optimistic markets will likely take this on board, but far from indicating a turn-around for the economy it should be a warning sign for equities and bitcoin in particular.  Gold and silver may well benefit, though, as safe haven investments, particularly if the dollar index has now peaked, as it may have done, as some of the currency weaknesses that had been driving it upwards appear to have dissipated somewhat.

29 Oct 2022 | Categories: Gold, Silver, Dollar, US, FOMC, Platinum, Palladium, Bitcoin, inflation

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