LAWRIE WILLIAMS: What to make of Thursday’s U.S. CPI announcement.
The Bureau of Labor Statistics duly announced the latest U.S. Consumer Price Index (CPI) inflation data for September on Thursday and, as we had predicted the announcement confirmed that inflation remained high and, in our view, worryingly so. However, again as we had forecast, the headline rate was marginally lower year on year, although the core rate, which ignores the energy and food elements, was significantly higher.
We had warned, though, that it was the core level which the markets should be mostly concerned about, and that was definitely reflected in the movement in the Chicago Mercantile Exchange’s Fedwatch Tool which analyses the probability of FOMC rate moves for upcoming meetings. Using 30-Day Fed Fund futures pricing data, which have long been relied upon to express the market’s views on the likelihood of changes in U.S. monetary policy, the tool visualises both current and historical probabilities of various FOMC rate change outcomes for a given meeting date.
From around a 70:30 likelihood of the Fed imposing a 75 basis point rate increase at the November FOMC meeting rather than a 50 basis point one, the odds appear to have risen, as I write, to a 99.3% chance of the 75 basis point rate rise with the remaining 0.7% suggesting a 100 basis point rise. What might be considered even more worrying for the U.S. economy, the Fedwatch Tool is now predicting a 71.6% chance of a further 75 basis point rate rise at the December FOMC meeting which would make five months in a row of similar-sized rate increases and bring the year-end Federal Funds rate to 4.5-4.75%. Given that we started the year at 0-0.25% that is an enormous rise over the 12-month period and if anything would confirm that the U.S. is currently in economic recession that would.
One would thus perhaps have expected equity markets to tank on this prospect. But contrary to any logic we could see, quite the reverse happened and they soared with investors seizing on the small fall in the headline year-on-year inflation rate as a sign that the inflationary beast might have peaked. But as we had warned it is the core level which should be the principal cause for concern. Higher interest rates and continued Fed tightening, which as yet shows no signs of being reduced, is going to eat into corporate profit margins and threaten earnings, and make some foreclosures on overstretched businesses and bankruptcy growth inevitable. The U.S. higher interest rate raising patterns are going to be replicated elsewhere in the world and we look to be facing a serious global recession as a partial consequence.
While the U.S. Fed seems to view ongoing high inflation levels as something which has to be kept in check, the investment public appears to be acting as if it doesn’t care. At some stage though, reality in the form of across the board earnings downturns will start to materialise and some of the current investment euphoria will undoubtedly reverse. The shakeout could be quite dramatic and severe.
Meanwhile the aggressive interest rate policy has been keeping the dollar index strong and this has been having a debilitating effect on gold and silver prices in particular. Gold has come back to the $1,640s in U.S. dollar terms, although has not declined nearly as much in a number of other major currencies. We still feel that it has the potential to recover strongly from this kind of nadir, while we’d reckon on equities falling and bitcoin (BTC), which seems to have been hovering above and below the $19,000 mark, perhaps weakening a little as recessionary trends bite.