Weekly Hard Assets Insights
By David McAlvany

Shifting Sentiment: What’s Really Transitory?

It was another active week for markets and market relevant news. The stock market continued to digest corporate earnings, new inflation and consumer sentiment data arrived, Federal Reserve officials talked of tapering, and the potential for a combined $4.5 trillion in fiscal stimulus gained headlines. Several major market indices closed the week at new record highs, the dollar lost it’s footing on Friday, and gold had a volatile week for the ages. Gold’s action this week necessitates special mention in the weekly volatility hall of fame. After Gold’s “mini flash crash” late Sunday night that sent its price dramatically lower, all the way to 1675.90, testing the March double bottom lows, the yellow metal actually managed to close the week higher. It was quite a week.

CPI data released Wednesday indicated that the explosive growth in U.S. inflation seen in recent months may have stabilized for now, but also indicated that high inflation remains stubbornly persistent. The Labor Department reported that the consumer price index increased 0.5% in July after climbing 0.9% in June. The report eased concerns over the potential for imminent runaway inflation, but didn’t remove the inflation problem from the list of concerns facing the economy, consumers, corporations, and markets. Year over year, CPI increased 5.4% vs. expectations for a 5.3% increase according to economists surveyed by Dow Jones. Core inflation (excluding energy and food prices) rose by 0.3% vs 0.4% expectations.

On Thursday, producer price data was released. July PPI increased by 1% for the second straight month, coming in higher than the 0.6% expected by economists. Year over year, PPI registered a 7.8% increase that amounts to the highest reading since 2010 when 12-month records were started. Core PPI also increased 1% for the month, while the 12-month increase was 6.2%.

In response to the data, Kansas City Federal Reserve President Esther George said that with strong U.S. economic growth, the data suggests that, for the Fed, the “time has come to dial back the settings.” Dallas Federal Reserve President Robert Kaplan also chimed in on Fed policy. Kaplan said the Fed should announce its timeline to reduce stimulus next month, and begin tapering in October.

There were some indications, however, that market participants were not convinced. One of the more interesting, albeit perhaps subtle, related developments this week occurred in the options market. In light of the perception of a more hawkish Fed of late, the futures markets’ consensus currently anticipates a first Fed rate-hike by the end of 2022 with rates, at that time, expected to be around 0.46%. With further rate hikes anticipated, futures markets then imply rates of around 1.46% by the first quarter of 2025. Recently, however, particularly since this week’s CPI and PPI numbers, there are increasing signs in the options market that a rapidly growing number of market participants are starting to significantly weight scenarios well outside of the current consensus expectation for reduced FED stimulus and rake hikes.

According to Bloomberg, this week saw certain call option-buying activity dramatically light up. This oh-so-interesting options activity amounts to positions that will pay off if, unlike the current consensus, the Fed doesn’t raise it’s benchmark funds rate, but rather maintains the lower bound until the spring of 2025. These options expire in March of 2022. So, more precisely, the option activity is speculating that market consensus will readjust from the current consensus for rate hikes all the way to a new consensus expectation for no rate hikes, and that this will happen by next March. That would truly be a dramatic shift from where current market expectations are at present.

So, what does this all mean? Well, it may mean a number of things, but one fact is certain; the options market is suddenly paying a lot more attention to a no-rate-hike scenario. Recent issues of Hard Asset Insights have described any future Fed efforts to withdraw stimulus and increase interest rates as a perilous tightrope walk. This is because of the very apparent array of factors seemingly poised and conspiring to knock the Fed firmly off that course.

For one thing, there are very real emerging cyclical growth concerns. These growth concerns were underscored by the significantly below-expectation recent GDP release, as well as by recent PMI manufacturing data that has disappointed and seems to have already rolled over from a peak. On top of the weakening growth readings, the Covid Delta variant—not to mention the possibility of new variants—has emerged as a viable threat to growth as well. Significantly, given the Fed’s employment mandate, these factors could be expected to have negative implications for a continued labor market recovery in the coming months.

In addition, inflation continues to put pressure on consumers and corporations alike at the same time as a vulnerable stock market, already stretched to record valuations, is pricing in what may well be unrealistic earnings expectations. All this is to say that growth concerns, signs of labor market fragility, and significant weakness in major market averages would form an environment in which the Fed is not at all likely to withdraw stimulus or raise rates.

Adding another very troubling factor into the mix was the latest University of Michigan preliminary sentiment survey released on Friday. According to the survey’s chief economist Richard Curtin, “Consumers reported a stunning loss of confidence in the first half of August.” The sentiment index plunged by 13.5% from July to actual readings below the April 2020 Covid crisis lows. This is a truly shocking development. Curtin goes on to point out that, “Over the past half century, the Sentiment Index has only recorded larger losses in six other surveys, all connected to sudden negative changes in the economy: the only larger (percentage) declines in the Sentiment Index occurred during the economy’s shutdown in April 2020 (19.4%) and at the depths of the Great Recession in October 2008 (18.1%).” The weakness in the sentiment readings was pervasive across the economy from personal finances, prospects for the economy, inflation expectations, and unemployment. All categories of age, income, education, and region displayed the weakness.

What the above-mentioned options activity suggests is that the market may be catching on and waking up to the difficulties facing the Fed’s path towards normalization. Market participants are now showing some real signs of doubt, and are starting to hedge against the risk that the consensus on future rates is wrong, and that the Fed will be unable to withdraw its ultra-accommodative policy. With all the endless Fed talk of “transitory” inflation over the last year, it would be poetic irony if history testifies that it was Fed policy normalization plans that were ultimately “transitory.”

As for weekly performance: The S&P 500 closed the week up 0.71%. Gold was higher on the week by 0.86%, while silver lost 2.26%. Platinum had a strong week, up 5.53%, while palladium was higher by 1.00%. The HUI gold miners index lost 1.82%. The IFRA iShares U.S. Infrastructure ETF was up 2.14%. Energy commodities were mixed again this week. Despite a great deal of volatility, oil ended little changed on the week, up 0.23%. Natural gas, on the other hand, dropped by 6.63%. The CRB Commodity Index was up 0.84%, while copper gained 0.94%. The Dow Jones U.S. Real Estate Index ended the week down 0.09%, while the Dow Jones Utilities Index added 1.25%. The dollar was down 0.29% to close the week at 92.51. The yield on the 10-yr Treasury had a very volatile week, again shedding 3 bps to close the week at 1.28%.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC