It was a relatively uneventful trading day yesterday, as gold declined by 0.30%, the GDX ETF by 0.64%, the GDXJ ETF by 0.96% and the USD Index by 0.27%. In contrast, silver rallied by 0.20%.
However, the GDXJ ETF continued to underperform the S&P 500, as the latter declined by 0.30%. Therefore, our short position continues to execute, and more downside should confront the pair over the medium term.
PMI Problems
With investors in wait-and-see mode for the next fundamental catalyst to propel financial assets in either direction, the prospect of pension fund rebalancing has market participants relatively upbeat. Moreover, with Independence Day on July 4, we may have to wait until after the holiday for the next bout of volatility.
However, while short-term sentiment may have found a floor, the medium-term fundamentals continue to deteriorate. For example, the Dallas Fed released its Texas Manufacturing Outlook Survey on June 27. The headline index declined from -7.3 to -17.7, as the figure “reached lows last seen in May 2020.” In addition, “the outlook uncertainty index shot up to 43.7, a 17-point jump from May.”
More importantly:
“Labor market measures continued to indicate robust employment growth and longer workweeks. The employment index moved down six points to 15.2 but remained well above its series average of 7.7. Twenty-four percent of firms noted net hiring, while 9 percent noted net layoffs. The hours worked index pushed up further, from 7.4 to 11.8.”
In addition:
“Prices and wages continued to increase strongly. The raw materials prices index edged down to 57.5, a reading still more than twice its average of 28.0. The finished goods prices index also moved down, from 41.8 to 33.8, but remained highly elevated. The wages and benefits index came in at 49.9, unchanged from May and markedly higher than its 20.4 average.”
As a result, hawkish implications for the Fed’s dual mandate – maximum employment and price stability – remain alive and well in Texas. Moreover, while output has suffered amid higher interest rates, the pricing pressures remain problematic. For example, with manufacturers increasing their inflation expectations in June, the Fed’s catch-22 is on full display.
Please see below:
Source: Dallas Fed
To explain, survey respondents are periodically asked about their wage, input, and output price expectations. If you analyze the red box, you can see that all three increased from March to June. Therefore, while investors hope that a few rate hikes will suppress inflation’s reign, manufacturing firms in Texas expect more inflation now than they did in March. As a result, six rate hikes (25 basis point increments) have done little to curb realized or expected inflation.
Likewise, the New York Fed released its Empire Manufacturing Survey on Jun. 15. Moreover, while the headline index increased month-over-month (MoM), so did inflation. The report revealed:
“The index for the number of employees increased five points to 19.0, pointing to a solid increase in employment, and the average workweek index came in at 6.4, indicating a small increase in hours worked.”
In addition:
“The prices paid index rose five points to 78.6, several points below its recent record high, and the prices received index edged down to a still elevated 43.6, signaling ongoing substantial increases in both input prices and selling prices.”
Please see below:
Source: New York Fed
Singing a similar tune, the Philadelphia Fed released its Manufacturing Business Outlook Survey on Jun. 16. The headline index declined six points to -3.3. However:
“Firms continued to report increases in employment, and the employment index moved up from 25.5 to 28.1. More than 31 percent of the firms reported increases in employment, compared with 3 percent that reported decreases; 66 percent reported no change. The average workweek index decreased 4 points, to 11.8.”
Likewise:
“The indicators for prices paid and prices received continue to indicate widespread price increases but decreased this month.”
Therefore, while inflation was less fierce in Philadelphia, both prices paid and received indexes remain stubbornly high.
Please see below:
Source: Philadelphia Fed
Finally, the Kansas City Fed released its Tenth District Manufacturing Activity survey on Jun. 23. The headline index also declined, falling from 23 in May to 12 in June. Moreover, while the employment index also declined, the prices received index increased from 42 in May to 51 in June.
Furthermore, the majority of respondents claim it’s easier to raise prices now than in January.
Please see below:
Source: KC Fed
If you analyze the blue bars furthest to the right, you can see that roughly 55% of respondents said their ability to pass through higher input costs has either “slightly” or “significantly” increased since the start of the year.
As a result, inflation dynamics are not heading in the Fed’s desired direction. Therefore, the central bank will have to choose between supporting growth and stoking inflation or pressuring growth and defeating inflation. However, I’ve long warned that the former approach pushed the U.S. into recession four times over ~12 years in the 1970s/1980s.
Thus, a half-hearted approach to calming the pricing pressures results in more long-term damage than simply raising rates and inducing a recession. Furthermore, I noted on June 23 that Fed Chairman Jerome Powell understands the precarious pitfalls and realizes that a dovish pivot would be a disaster. I wrote:
I warned on numerous occasions that letting inflation rage would be the worst long-term outcome for the U.S. economy. In a nutshell: turning dovish would hurt the U.S. dollar and embolden commodity traders to bid up prices even more.
As a result, Powell must follow through with his hawkish threats or the progress will reverse and he’ll be back to square one. However, he sounds like a man who realizes that fighting inflation is the only plausible path forward. Moreover, a rising unemployment rate won’t be enough to deter future rate hikes.
Please see below:
Source: Reuters
Melancholy in Michigan
The University of Michigan released its Consumer Sentiment Index on Jun. 24. Moreover, with the index hitting a new all-time low, I’ve highlighted how inflation is both a financial and political problem. The report revealed:
“The final June reading confirmed the early-June decline in consumer sentiment, settling 0.2 Index points below the preliminary reading and 14.4% below May for the lowest reading on record. Consumers across income, age, education, geographic region, political affiliation, stockholding, and homeownership status all posted large declines.”
“About 79% of consumers expected bad times in the year ahead for business conditions, the highest since 2009. Inflation continued to be of paramount concern to consumers; 47% of consumers blamed inflation for eroding their living standards, just one point shy of the all-time high last reached during the Great Recession.”
Likewise:
“Consumers also expressed the highest level of uncertainty over long-run inflation since 1991, continuing a sharp increase that began in 2021.”
Please see below:
To explain, the black and red dotted lines above track respondents’ median one-year and 5-10-year inflation uncertainty. If you analyze the right side of the chart, you can see that the black line is on par with the global financial crisis (GFC) highs. However, the red dotted line has eclipsed its GFC highs, as long-term inflation has become embedded in Americans’ psyches.
Again, the gray bars on the left show how high inflation is the perfect predictor of U.S. recessions. Therefore, the Fed must address the problem to avoid a decade of economic fits and starts.
To that point, the 1970s-like sentiment-unemployment rate divergence has likely sowed the seeds of an economic malaise.
Please see below:
To explain, the dark blue line above tracks the University of Michigan’s Consumer Sentiment Index, while the light blue line above tracks the inverted U.S. unemployment rate. For context, inverted means the latter’s scale is flipped upside down, and a rising light blue line represents a falling U.S. unemployment rate.
Moreover, if you analyze the left side of the chart, the vertical gray bars and annotations show how unanchored inflation often decouples sentiment from the unemployment rate and results in a recession. Likewise, the epic divergence on the right side of the chart is even worse.
In a nutshell: failing to curb the pricing pressures eventually leads to demand destruction, a rising unemployment rate and a recession. Therefore, if Fed officials fail to act, history shows that inflation will inflict pain. As such, directly dealing with the issue is the lesser of two evils.
The Bottom Line
While investors assume that weakening growth will provoke a dovish pivot, a patient Powell won’t cure the U.S.’s economic ills. In contrast, turning dovish would worsen the situation and elicit a re-enactment of the 1950s to 1980s. As evidence, notice how the gray bars (recessions) on the left side of the chart above are more clustered together than on the right? Well, it’s no coincidence that these periods culminated with unanchored inflation. Moreover, the chart below highlights the ominous dynamic.
As such, if Powell wants the U.S. to enjoy a post-1983 economic environment, he needs to get inflation under control.
In conclusion, the PMs were mixed on Jun. 27, as silver ended the day in the green. However, with investors awaiting the next fundamental catalyst, the short-term price action may be subdued. Despite that, the medium-term outlook is unchanged: hawkish Fed policy is necessary to curb inflation, and that realization should uplift the USD Index and U.S. real yields. As a result, the PMs should head in the opposite direction over the medium term.