While the PMs attempt to defy fundamental gravity, U.S. Treasury yields continue to march higher. With the U.S. 10-year Treasury yield hitting another 2022 high of 1.97% on Feb. 8, rising interest rates remain a fundamental headwind for gold, silver and mining stocks.
Source: Investing.com
With the Treasury benchmark hovering near a key positioning level, sustained momentum could lead to frantic hedging and push the U.S. 10-Year Treasury yield even higher.
Mortgage-bond investors hedge their positions by shorting U.S. Treasuries or purchasing interest rate swaps. In a nutshell: when interest rates rise, the goal is to offset the losses on long mortgage bond positions by making money on short U.S. Treasury positions.
With 1.95% as a critical level, Citigroup strategists William O’Donnell and Edward Acton told clients that they “saw no strong fingerprints” of hedging on Feb. 4. However, “a breach of 1.95% in 10’s might spur some.” As a result, if institutional investors start fearing another ‘taper tantrum,’ we may witness an extreme move higher.
Moreover, while the PMs take solace in investors’ belief that the Fed will come to the rescue, this time really is different. For one, the Fed often rescues investors when trouble materializes in the riskiest corners of the credit market. However, with volatility only present in the stock market, the ‘Fed put’ is likely much lower than current levels.
Not coming to the rescue
On the chart above, the yellow line tracks the S&P 500, while the white line tracks Bloomberg’s high-yield option-adjusted spread. For context, when the white line is rising, it means that investors require higher interest rates to compensate for the perceived default risk. Conversely, when the white line is falling, investors accepting lower interest rates by default is less likely.
If you analyze the red circle near the middle of the chart, you can see that the Fed flipped from hawkish to dovish in late 2018 after high-yield credit markets freaked out (depicted by the white line rising sharply). Similarly, the Fed fired its QE bazooka when the white line went to the moon during the coronavirus crisis.
However, if you analyze the right side of the chart, you can see that the white line remained relatively calm even as the S&P 500 sold off. As a result, it will likely take more stock market weakness before the Fed changes its tone.
Second, I’ve warned on numerous occasions that the U.S. economy remains on solid footing. Since a bullish U.S. economy is bearish for the PMs and the NASDAQ Composite, the more economic growth increases, the more the Fed keeps its foot on the hawkish accelerator.
To that point, while the Omicron variant has hurt in-person activity, the latest data from the U.S. Bureau of Economic Analysis (BEA) shows that Americans are still swiping their debit and credit cards.
The red and blue lines above track the baseline and four-week moving average percentage changes in Americans’ debit and credit card spending. If you analyze the right side of the chart, you can see that consumer spending remains on the up and up.
As further evidence, the Chicago Fed’s Advance Retail Trade Summary (CARTS) tracks U.S. retail sales every week. In a nutshell: it tries to predict the government data that comes out each month. After correctly predicting a decline in December, the Chicago Fed expects U.S. retail sales to increase by 0.40% month-over-month (MoM) in January.
Source: Chicago Fed
Third, Indeed released its latest U.S. job openings report on Feb. 8. An excerpt read:
"It seems like the worst of the Omicron surge’s impact might have passed. New job postings (those on Indeed for 7 days or less) are at a series high. As of February 4, new postings are 82.2% above pre-pandemic baseline, up 13 percentage points since last week.
"...job postings in all occupational sectors are above pre-pandemic baseline, especially human resources and software development."
Fourth, the NFIB released its Small Business Optimism Index on Feb. 8. While the headline index declined from 98.9 in December to 97.1 in January, NFIB Chief Economist Bill Dunkelberg said that:
"more small business owners started the New Year raising prices in an attempt to pass on higher inventory, supplies, and labor costs. In addition to inflation issues, owners are also raising compensation at record high rates to attract qualified employees to their open positions."
To that point, an excerpt from the report read:
"The net percent of owners raising average selling prices increased 4 points to a net 61 percent seasonally adjusted, the highest reading since Q4 1974."
Source: NFIB
As for wage inflation:
"Seasonally adjusted, a net 50 percent reported raising compensation, up 2 points from December and a 48-year record high reading.”
Source: NFIB
On top of that, while I sounded the inflationary alarm throughout all of 2021, the mainstream finally realizes that inflation is far from “transitory.”
Source: NFIB
Speaking of wage inflation, Goldman Sachs’ Wage Tracker is also at record highs.
The blue line above tracks the three-month annualized change in average hourly earnings, while the red line above tracks Goldman Sachs (NYSE:GS)' Wage Tracker. If you analyze the right side of the chart, you can see that the latter is now at an all-time high.
Goldman Sachs' Chief Economist, Jan Hatzius, warned clients that the wage tracker has "accelerated to a 6% annualized rate over the past 2-3 quarters" and that "the broadening of wage and price pressures across the advanced economies implies that growth needs to slow and financial conditions need to tighten at an earlier stage of the recovery than previously expected."
The bottom line? While the PMs assume that all is well on Wall Street, the outperformance of commodities in January only enhances the inflationary pressures.
With weak data needed for the Fed to perform a dovish 180, the strength of the U.S. labor market signals the exact opposite. Moreover, while investors assumed that the end of enhanced unemployment benefits would kill consumer spending, there is still plenty of cash (too much) in the system.
As a result, the Fed should remain on its hawkish warpath, and higher U.S. Treasury yields and a stronger USD Index will likely be the end result.
In conclusion, the PMs rallied on Feb. 8, as tepid optimism from the S&P 500 helped uplift sentiment. However, while investors hope that the Fed won't drop the hawkish hammer, the reality is that the U.S. economy remains on solid footing.
As a result, the Fed should raise interest rates at its March monetary policy meeting. Moreover, with history revealing that U.S. Treasury yields and the USD Index are often the main beneficiaries of the Fed's rate-hike cycle, another re-enactment should be unkind to the PMs.