Weekly Hard Assets Insights
By David McAlvany

The Fed, A lit Match, and A Powder Keg

Without question, this past week was a punishing one in the commodity sector. The Wednesday FOMC meeting proved to be a catalyst for broad-based selling in hard assets and all things inflation trade-related. Hard commodities, soft commodities, precious metals, and inflation breakeven rates all sank while the dollar surged. The financial media was quick to attribute the carnage to a bold hawkish pivot on the part of Federal Reserve policy. Before we examine that narrative, however, lets back up and establish some context in which to place this week’s market action.

In the Hard Assets Insights column from the first week in June, it was noted that, in terms of market sentiment, technicals, and historical seasonality, the price of gold was due for a corrective phase. In the same piece, it was pointed out that the U.S. dollar was, conversely, oversold while trading near major five-year technical price support levels that, taken together, provide “an ideal opportunity for a US dollar bounce.”

The point made regarding gold, especially the overbought technical condition and hot sentiment, can be appropriately extended toward the overall commodity sector as a whole. For example, the broad commodity CRB index tracking a wide-ranging basket of commodity prices has been in an extremely overbought technical condition on the weekly chart since the start of 2021 as commodity prices continued to surge higher. As these technical conditions persist over time, the odds increase for a price correction at some point that works off technically overbought conditions and excessively bullish investor sentiment.

To illustrate the point, after an almost 110%, nearly uninterrupted, rally off the Covid lows in the CRB index, the weekly price chart reached overbought levels seen only three times over the preceding 20+ year period. Despite the bullish commodity fundamentals and bearish dollar fundamentals that have been moving these two markets, the technical price extremes that have been accumulating create something of a volatile powder keg increasingly vulnerable to a match. This week, the Fed provided that match.

Given the dramatic volatile reactions in markets following Wednesday’s FOMC meeting, it is easy to extrapolate that the Fed just flexed a new-found hawkish muscle that will end commodity price appreciation and halt the inflation trade dead in its tracks. In light of the above-mentioned technical context, however, the fundamental reality may be far less dramatic.

Actually looking at the Fed statements, Chairman Powell described this Wednesday’s meeting as the “talking about talking about meeting.” The reference was to previous statements where Powell had said that the Fed was not yet even talking about talking about tightening monetary policy. So, officially, the first baby step of initiating the process of re-examining Fed policy has begun. That alone should come as no surprise after the string of significantly hotter-than-expected inflation data consistently released over the last few months that culminated in last week’s 5% CPI print. The remarkable thing would have been if the Fed had done nothing but maintain its previous, largely dismissive “transitory” language on inflation.

What is perceived as a larger shift is what the Fed included regarding expectations for raising rates in the future. The Fed has tethered any change in interest rates to employment and inflation. They want inflation to moderately exceed 2% “for some time” and want to see labor market conditions reach levels consistent with “the Committee’s assessment of maximum employment.” Fed Chairman Powell went on to say that, “many participants forecast that these favorable economic conditions will be met sooner than previously projected….”

Accordingly, the Fed’s updated projections now show the Fed funds rate starting to emerge from the basement in 2023 rather than 2024 previously. In addition, the Fed upwardly revised expectations for U.S. growth and higher inflation for this year. Once again, this was not a surprise, but rather the Fed finally starting to acknowledge the data that has already been amassed.

A number of analysts had already been expecting some greater acknowledgement of data and some degree of concurrent signaling toward sooner-than-previously indicated tightening. So, rather than these changes signaling a dramatic change of stance, they more closely resemble a Fed that is catching up with the reality of the data and what the markets have been chewing on for quite some time.

As far as looking forward, the same issues and potential contradictions that were clouding the future before the meeting are very much present after it, as well. Yes, inflation is running hot. However, as the Fed has been saying for months, some of what is driving inflation should prove, over time, to be somewhat “transitory.” On the other hand, some of the factors driving inflation higher with more persistence than the Fed expected are powerful, quite sticky, and may prove to be non-transitory. In Wednesday’s statement, the Fed acknowledged as much, saying, “inflation could turn out to be higher and more persistent than we expect.”

The labor market has improved, but the weakness in new jobs coming in well below expectations has been the bigger story. Powell says that he is confident that “we are on a path to a very strong labor market – a labor market that shows low unemployment, high participation…[and] rising wages….” Well, we are a long way away from all of that, and those “rising wages” are one of the factors that may accentuate an inflation problem that’s already run well beyond Fed guidance.

Adding to the potential contradictions, to mute inflation concerns and support inflation returning to Fed forecast levels, we are told that the expectation is that growth will not be as torrid in 2022 as in 2021. A significant factor contributing to this is the expectation that there will be much less fiscal stimulus. Meanwhile, last week at the G7 in England, there was unanimous support for more fiscal stimulus. Reuters reported last week “broad agreement about the need to continue supporting their economies with fiscal stimulus…. [T]he backing for more stimulus was shared by all leaders….” The Reuters’ report continued, “There was broad consensus across the table on continued support for fiscal expansion at this stage,” adding that “Biden, British Prime Minister Boris Johnson, and Italy’s Mario Draghi expressed particular support.”

So, there are many contradictions at play, and many moving pieces to this puzzle that have yet to be fully resolved. At the end of his statement, Powell closed with the following: “…the last thing I’ll say is, this is an extraordinarily unusual time. And we really don’t have a template or, you know, any experience of a situation like this. And so I think we have to be humble about our ability to understand the data. It’s not a time to try to reach hard conclusions about the labor market, about inflation, about the path of policy…we need to be a little bit patient. And I do think, though, that we’ll be seeing some things coming up in coming months that will inform our thinking.”

I agree with Chairman Powell here, but I’m not so sure that leaving your foot on an accelerator pinned to the floor to the tune of $120 billion a month in asset purchases, along with zero interest rate policy, is particularly an exercise in patience. Nor does it seem clear that months of adamantly and repeatedly dismissing any inflation concerns while those unprecedentedly aggressive policies are in place is particularly humble.

That said, We will see how this week’s market volatility plays out in the weeks and months ahead, but be aware that at least some of this week’s carnage can be attributed to the technical powder keg that had been building over time in various markets. One thing the Fed certainly accomplished this week, willingly or unwillingly, was to offer itself as a lit match.

As for weekly performance: The S&P 500 was down 1.91%. Gold was hit to the tune of 5.88%. Silver was down 7.74%. Platinum was down 9.56%, while palladium was crushed 11.18% on the week. The HUI gold miners index was pummeled, down 11.81%. The IFRA iShares U.S. Infrastructure ETF was down 6.04%. Energy commodities were mixed on the week, largely due to a very bullish crude oil inventory drawdown. Oil was actually up 0.55%, while natural gas prices were down 2.58%. The CRB Commodity Index was off 3.01%. Copper was down 8.38%. The Dow Jones US Real Estate Index ended the week off 3.06%, while the Dow Jones Utilities Index was down 3.07%. The dollar surged on the week by 1.83%. The yield on the 10-year Treasury dropped 2 bps to 1.45%.

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC