Despite the fact that the financial markets were closed for the Easter holiday, there was still plenty of drama. For example, the US 10-Year real yield hit 0% and briefly turned positive for the first time since 2020, the US Dollar Index topped 101, and Fed officials warned of several rate hikes in the coming months.
However, while all of these developments are fundamentally bearish for the PMs, the most crowded trade on Wall Street has the commodities complex sitting pretty.
Please see below:
While Netflix's (NASDAQ:NFLX) drubbing on Apr. 20 should be a cautionary tale of the consequences of deteriorating fundamentals, the PMs remain uplifted, but with the medium term likely to elicit a material shift in sentiment, don't be surprised if investors' wrath is eventually thrust upon them.
To explain, the devil is in the details, and when you watch for subtle clues, the puzzle pieces come together. For example, I warned on Apr. 13 that Fed officials' messaging couldn't be clearer. I wrote:
Fed Governor Lael Brainard said on Apr. 12: “Inflation is too high, and getting inflation down is going to be our most important task.”
More importantly, notice her use of that all-important buzzword.
Source: Reuters
And:
Source: Reuters
Moreover, where do you think she got it?
Source: Reuters
Likewise, St. Louis Fed President James Bullard said on Apr. 18 that inflation is “far too high” and that a rapid rise to neutral is the most likely outcome. For context, he wants to increase the US federal funds rate to 3.5% by the end of 2022. Moreover, there is that word again:
Source: Reuters
Continuing the theme, San Francisco Fed President Mary Daly said on Apr. 20 that a 50 basis point rate hike in May is "complete" and "solid." As a result, it's like Fed officials have morphed into those toys that repeat the same message when you pull the string.
Please see below:
Source: CNBC
As further evidence, can you guess what Chicago Fed President Charles Evans said on Apr. 11?
Source: Reuters
Therefore, do you think it’s a coincidence that Fed officials are repeating the same message? Of course not. After the FOMC’s December monetary policy meeting, I warned that Chairman Jerome Powell uses his deputies to deliver remarks on his behalf. I wrote on Dec. 16:
As one of the most important quotes of the press conference, [Powell] admitted:
“My colleagues were out talking about a faster taper, and that doesn’t happen by accident. They were out talking about a faster taper before the president made his decision. So it’s a decision that effectively was more than entrained.”
While Powell sounded a little rattled during the exchange, his slip highlights the importance of Fed officials’ hawkish rhetoric. Essentially, when Clarida, Waller, Bostic, Bullard, etc., are making the hawkish rounds, “that doesn’t happen by accident.” As such, it’s an admission that his understudies serve as messengers for pre-determined policy decisions.
To that point, Evans added on Apr. 19:
“On the way to December, you’d be looking for any confirmation of the storyline. It could be that short-term neutral is actually lower, and that by the time we get to 2.5%, it’s actually contractionary for a variety of reasons. It could go the other way too.”
However, given the state of inflation, he realistically said: “Probably we are going beyond neutral. That’s my expectation.” As a result, more than one 50 basis point rate hike is on the table.
Please see below:
Source: Reuters
Also noteworthy, Atlanta Fed President Raphael Bostic was the most dovish of the crew this week. He said:
“I really have us looking at one and three-quarters by the end of the year, but [inflation] could be slower depending on how the economy evolves and we do see greater weakening than I’m seeing in my baseline model. This is one reason why I’m reluctant to really declare that we want to go a long way beyond our neutral place, because that may be more hikes than are warranted given sort of the economic environment.”
However, stating that the neutral U.S. federal funds rate could range from 2% to 2.5% or be as low as 1.75%, he remains aligned with the FOMC's median projection of six more rate hikes (seven in total) in 2022. Also, there is that word again.
Source: CNBC
As a result, it’s funny how obvious Fed officials’ messaging has become. In a nutshell: Powell sets the tone, and his deputies recite his message in hopes that investors will react accordingly. However, with investors in denial and/or unable to see the forest through the trees, they’re not heeding the warnings.
Ironically, the U.S. technology sector has been decimated in recent months, while commodities remain uplifted. However, seven to 12 rate hikes over nine months will heavily impact demand and are materially bearish for commodities’ fundamentals. Therefore, one could argue that commodities have more to lose in the coming months than technology stocks.
In any event, investors seem to believe that either inflation will subside on its own or the Fed will back off. However, neither outcome is realistic. I’ve mentioned on numerous occasions that political ramifications should keep the pressure on the Fed. As a result, as long as inflation persists, the prospect of a dovish 180 is slim to none. To explain, I wrote on Apr. 20:
CNBC released its All-America Economic Survey on Apr. 13. The report revealed that “47% of the public say the economy is ‘poor,’ the highest number in that category since 2012. Only 17% rank the economy as excellent or good, the lowest since 2014.”
Please see below:
Likewise, I’ve also noted on numerous occasions that U.S. President Joe Biden’s approval rating is inversely correlated with inflation.
As a result, while investors assume that the Fed will bow down to the financial markets, the reality is that the game has changed. Previously, the Fed could support asset prices without the general public noticing. Now, inflation is front-page news and is hurting middle-class and poor Americans. Therefore, the Fed has to deal with the issue, and political pressure should force officials’ hands, whether they like it or not.
To that point, the inflation data continues to sizzle. For example, the Fed released its Beige Book on Apr. 20. The report revealed:
Source: U.S. Fed
As for wage inflation:
“Employment increased at a moderate pace. Demand for workers continued to be strong across most Districts and industry sectors. But hiring was held back by the overall lack of available workers, though several Districts reported signs of modest improvement in worker availability. Many firms reported significant turnover as workers left for higher wages and more flexible job schedules.”
“Persistent labor demand continued to fuel strong wage growth, particularly for footloose workers willing to change jobs. Firms reported that inflationary pressures were also contributing to higher wages, and that higher wages were doing little to alleviate widespread job vacancies. But some contacts reported early signs that the strong pace of wage growth had begun to slow.”
As a result, with inflation and employment still holding firm, this is bullish for Fed policy and bearish for the PMs.
Furthermore, Procter & Gamble (NYSE:PG) released its third-quarter earnings on Apr. 20. For context, the company sells various consumer staples and household products. CFO Andre Schulten said during the Q3 earnings call:
“We said each quarter that we will undoubtedly experience more volatility as we move through the fiscal year. We've seen another step in cost pressures, and foreign exchange rates have moved further against us. Transportation and labor markets remain tight. Availability of materials remains stretched in some categories and markets. Inflationary cost pressures are broad-based and continue to increase with little sign of near-term relief and have resulted in consumer price increases across CPG categories and beyond.”
Thus, Schulten noted that ~5% price hikes in Q3 will look more like ~6% in Q4.
Please see below:
Source: P&G/Seeking Alpha
For your reference, favorable price elasticities mean that when P&G raises prices, the company is not seeing a drop-off in demand. Moreover, P&G is no small fry. In fact, the company ranked second on Consumer Goods Technology's (CGT) 2021 Top 100 Consumer Goods Companies list. Therefore, it's more fuel for the hawkish fire.
Source: CGT
The bottom line? While the answers are hiding in plain sight, investors do what they usually do: they ignore the fundamentals until something breaks. Then, it’s a rush for the exits and the financial media does a post-mortem about why everyone should have seen it coming. However, it’s simply the nature of investor psychology.
Therefore, no matter how many times Fed officials say “expeditious-ly” or how much the inflation data supports even more hawkish policy, investors usually don’t get the message until it’s too late. However, when reality re-emerges, there will likely be a long way down before the PMs’ prices get to the oversold territory, from which another powerful rally could emerge.
In conclusion, the PMs were mixed on Apr. 20, as momentum still remains elevated. However, with real yields and the USD Index rising, the only things holding up the PMs are the Russia-Ukraine conflict and sentiment. Therefore, when the latter two wane and the former two remain, gold, silver, and mining stocks should suffer profound drawdowns.
What to Watch for Next Week
With more US economic data releases next week, the most important ones are as follows:
- Apr. 26: Confidence Board consumer confidence, Richmond and Dallas Fed’s manufacturing and services indexes, S&P/Case-Shiller home price index.
With consumer confidence providing insight into employment and inflation sentiment, the data highlights how “anchored,” or lack thereof, consumers’ medium-term expectations are with the Fed’s mandate. Likewise, the Richmond and Dallas Fed indexes are leading indicators of inflation and employment, while the S&P/Case-Shiller home price index offers a lagged look at housing inflation (which often leads to rent inflation).
- Apr. 28: Q1 GDP and Kansas City Fed manufacturing index.
GDP is lagged data, and investors are forward-looking. However, it's still important to monitor. Moreover, it will be interesting to see if the Kansas City Fed's data aligns with the Richmond and Dallas Fed's results.
All in all, economic data releases impact the PMs because they impact monetary policy. Moreover, if we continue to see higher employment and inflation, the Fed should keep its foot on the hawkish accelerator. If that occurs, the outcome is profoundly bearish for the PMs.