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Gold (XAU/USD-Spot) made a 5-day high around 1849.14 early U.S. sessions Thursday and well off the recent low of 1786.95 as US 10Y bond yield eased from +3.203% to +2.776% on the stagflation narrative. The US dollar index (DXY) also stumbled and made a 2-week low of around 102.73. Gold as well as UST is now a major beneficiary of safe-haven asset flow despite faster Fed tightening amid the concern of hotter inflation as such faster tightening is designed to slow the economy first and reduce demand, which may eventually match supply for any meaningful fall in inflation. The market is now concerned about imminent stagflation (lower economic growth, higher inflation and higher unemployment) and then an outright recession (lower economic growth, lower inflation and lower employment) by late 2023.
The Fed is now scrambling for bigger rate hikes to bring inflation down and preparing the market accordingly. The Fed will hike rates by +0.50% in June and July. Then depending upon the trajectory of inflation (core PCE) data for Q2 and Q3CY22 and the outlook thereof, Fed may hike at lower rates (+0.25%), if core PCE inflation data comes lower than being expected by the Fed, but may also hike at bigger rates (+0.75%) if it comes higher. And if inflation data continues to come as elevated as currently, then Fed will also continue to hike @+0.50% in September, November and December.
In brief, Fed will now watch actual core PCE/CPI inflation data for April-August/September and depending upon the data and evolving outlook may hike by +0.25% (if inflation eases significantly), +0.50% (if inflation does not ease or accelerate significantly) and +0.75% (if inflation accelerates further significantly). Thus the estimated neutral rate may be +2.75% or +3.50% or even +4.25% by Dec’22. But Fed may also front-load a +0.75% rate hike in September, followed by +0.50% each in November and December to reach Bullard’s latest estimate of a neutral rate of +3.75% by Dec’22 as a +4.25% neutral rate may invite another ‘Volcker Recession’, which Biden/Democrats may not allow ahead of Nov’24 Presidential election.
Although Fed is hoping for a softish landing while going for bigger rate hikes, Fed Chair Powell also is not ruling out completely the possibility of a hard landing. In any way, before Nov’24 election, Biden has to face Nov’22 mid-term election, in which he is set to lose the trifecta. Powell also knows that unless the problem of supply chain distortion and elevated commodity prices normalized because of Russia-Ukraine/NATO geopolitical tensions and economic sanctions, it will be very tough to bring down inflation by solely curtailing demand. This will also result in an economic hard landing/stagflation or even an outright recession, negative for Biden in Nov’22 mid-term election.
Thus Powell is virtually urging for a proper resolution/peace agreement of the Russia-Ukraine war and the lifting of economic sanctions. Despite a die-hard attempt by French President Macron and German Chancellor Scholz for a negotiation/ceasefire between Russia and Ukraine, nothing is happening as Ukraine/Zelensky admin will do nothing without the tacit approval of Biden admin. For any peace/ceasefire agreement between Russia and Ukraine, active participation and willingness of the U.S. are essential. Although Biden will use the anti-Russia narrative in the Nov’22 mid-term election to restore his falling approval rate/popularity, he may not linger Russia-Ukraine war further as it’s already affecting the U.S. as well as the global economy significantly contrary to earlier perception.
Fed Chair Powell knows that despite bigger rate hikes to engineer an economic slowdown and curtail demand, unless supply lines restore, inflation will not go below 2%. For price stability, AE like the U.S., Europe needs cheaper imported goods/commodities from developing economies like China (Asian exporters) and even Russia (Eastern Europe).
On Wednesday, Powell indicated elevated inflation will not come down meaningfully until there is a severe recession (as a result of faster Fed tightening) as-well-as supply chain resolution in China (from zero COVID policy) and Russia/Ukraine (through a peace agreement and withdrawal of the the the economic sanctions). It seems that Powell is not so much confident about both (China and Russia's supply chain issues). Thus Fed may have to go for bigger rate hikes even in September, November, and December to tame hotter inflation, which may also cause an economic hard landing or even an outright recession.
Fed’s primary objective is to bring down 1Y inflation expectations to around at least +2.50%, at pre-COVID levels by bigger rate hikes and ultra-hawkish jawboning. But so far, the strategy seems not working as 1Y inflation expectations continue to hover around +6.5%. In April, the 1Y inflation expectation (NY Fed data) was +6.3%, slightly eased from the recent high of +6.6% in March as headline CPI also eased to +8.3% in April from the 41-year high of +8.5% scaled in March.
The Q1CY22 sequential contraction in real GDP along with recent economic data suggests the U.S. economy may be already cooling amid elevated bond yields since Jan’22. On Tuesday, flash data shows that the U.S. economy clocked retail sales of around $677.711B in April against $671.648B sequentially (+0.90%) and $626.430B yearly (+8.33%). If we consider, the April inflation (CPI) annual/yearly rate of +8.3%, the real growth in retail sales is almost nil or even negative. In 2019 (pre-COVID), the average yearly growth of U.S. retail sales was around +3.30% against the headline CPI rate of +1.75%; i.e. the real growth in retail sales was positive in line with the Fed’s policy of 2% price stability (goldilocks economy).
Leading/big U.S. retailers like Wall Mart, and Target are now issuing guidance warnings because of hotter inflation, higher raw material/product cost, and discretionary spending of consumers are being affected heavily. Average middle-class consumers are now shopping mostly for essential items. As a reminder, consumer spending is the backbone of the U.S. as well as the global economy; almost 70% of U.S. GDP comes from consumer spending and China is the biggest beneficiary of U.S. consumer spending.
Looking ahead, Biden may withdraw Trump tariffs on Chinese goods ahead of Nov’22 mid-term election as a ‘gift’ (tax cut) to ‘hard-working Americans’. This, along with a recent surge in USDCNY (from around 6.35 to 6.85) may also help to bring down U.S. inflation slightly, but the complete restoration of the Chinese supply line along with the resolution of Russian sanctions are vital for any meaningful fall in inflation.
On Thursday, all focus was also on U.S. jobless claims, which serves as a proxy for the unemployment trend/overall labor market conditions.
The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI-under insurance) increased to 218K in the week ending 14th May from 197K in the previous week, above market expectations of 200K and the highest reading since the week ended 22nd January. The 4-week moving average of initial jobless claims, a better indicator to measure underlying data, as it removes week-to-week volatility, surged to 199.500K from 191.250K in the previous week and well-off from the early April low 170.500K.
The continuing jobless claims in the U.S., which measure unemployed people who have been receiving unemployment benefits for more than a week or filed unemployment benefits at least two weeks ago under UI, slips to 1317K in the week ending 7th May, from 1342K in the previous week and marginally below market expectations of 1320K. This is the lowest since 1969.
In the U.S. there were around 11549K job offers in March against 5941 unemployed persons in April; i.e. ratio is almost 2:1 (for each unemployed person, 2 jobs are available). Fed wants to cool such a hot job/labor market by tightening it so that wage inflation cools down, leading to a drop in headline inflation. Before COVID, the ratio was around 1.18:1. U.S. job openings are still elevated in retail trade and durable goods manufacturing. In any way, Fed needs to increase the number of unemployed persons and decrease job openings by faster tightening, so that the ratio of job openings/unemployed persons falls to pre-COVID levels.
There are already signs that U.S. economic growth is faltering, but at the same time, a huge Ukraine fiscal stimulus may also help the U.S. economy (in terms of military equipment production and other grants). Apart from the benefit of the U.S. military industry, U.S. oil & gas industry is also a big beneficiary of elevated prices of oil & gas amid the lingering proxy war between Russia-U.S./NATO over Ukraine and NATO expansion policy in Eastern Europe (Russian border states/countries). Apart from Russia and Ukraine, Europe is the biggest loser of the U.S. proxy war with Russia as Europe imports around 70% of its oil requirement and is heavily dependent on Russian oil & gas supplies.
And Putin is leveraging the Russian supply of oil & gas and certain other commodities including food items for his war on Ukraine. Putin is expecting that the West (Europe and the U.S.) will give him concessions over Ukraine issues as hotter inflation will invite recession and political unrest there. Now the question is whether Biden will blink and give concession to Putin for an amicable solution over Ukraine to bring inflation down ahead of Nov’22 mid-term election. Biden’s approval rate is plummeting because of elevated Bidenflation even before the Russian invasion of Ukraine and subsequent Putinflation.
The dual combination of Bidenflation and Putinflation may cause synchronized global stagflation or even an outright recession by late 2023. This may result in the launch of QE-5 by the Fed in early 2024 (ahead of Nov’24 U.S. Presidential election) along with another dose of fiscal stimulus by Biden (revised BBB package). Gold is a great beneficiary of lingering geopolitical tensions over Russia (which may cause WW III) and also the never-ending attraction of 3D (public debt, deficit and currency devaluation) coupled with elevated inflation. If we consider the average long-term oil/gold ratio of around 20 and the current average oil price of around $100, gold should scale around the $2000 mark again in the coming days, if the Russia-Ukraine war lingers for another few months. Higher oil is positive for inflation/gold and vice-versa.
Looking ahead, whatever may be the narrative, technically Gold now has to sustain over 1855 for a further rally towards 2000; otherwise sustaining below 1850, Gold may again fall to 1785-1705 levels in the coming days.
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