CPI Is Surging: Putting The FED In A Split

The Consumer Price Index (CPI) measures the change in the price of goods and services from the perspective of the consumer. It measures changes in purchasing trends and inflation. In May CPI rose to 5% year-over-year, putting increasing pressure on the FED to ensure price stability, one of the main objectives for the central bank.

The FED keeps on emphasizing that the current inflation numbers are just transitory and will not persist on the long run. The five percent year-over-year inflation should be taken with a grain of salt as consumers are finally free and are likely to spend hoarded non-spent cash as lockdowns are eased and lifted. Moreover, as can be seen in Figure 1, CPI changes were much lower during the initial months of the corona outbreak in the United States. Therefore, investors should be cautious to make any conclusions on these figures too soon. Even though Biden is held responsible for the current high inflation, it should be noted that current inflation is most likely the result of governmental spending throughout the corona pandemic.

Figure 1 – CPI changes point to inflation

Inflation is highest in the used car sector and the hotel & entertainment branch, both climbing in the double digits in April and May. The soaring prices in the used car segment are most likely partially the result of the continuing chip shortage which leads to increasing delivery times for new cars. Tesla has been having delivery problems for months now, leading to consumers waiting for over six months for their new car according to some reports. The re-opening hotels try the benefit from the urge to go on a holiday that many Americans have. Increased prices in this sector are also an effort to make-up for the losses made during the long-hauling lockdowns in some U.S. states. Iron ore prices dropped after Chinese regulators warned for excessive speculation in commodity markets as traders increasingly fear Chinese policies against price rises. Other commodities like lumber, rare earths and copper saw the same price action, which could mean that overall inflation could also drop in the mid-term. However, it should be noted that commodities are still at multi-year highs and their impact should not be underestimated.

FED Turns More Hawkish Than Expected, Side Effects Unknown

Wednesday FED chairman Jerome Powell announced that interest rates could rise as soon as 2023. However, some analysts suggest that the first interest rate hikes could be imposed as soon as the start of 2022. Moreover, the FED announced that it was looking to step down their QE-practices on the short run, building down the amount of U.S. debt on their balance sheet. Before it is so far the FED is continuing the purchasing of national debt papers up to 120 billion a month. Interestingly, Powell pointed out that the FED could also be wrong about their assessment that current inflation is just transitory, which could mean that the central bank will potentially interfere much earlier than expected. In a reaction to the more hawkish than expected FED gold equities lost big this week with the gold miners index losing more than ten percent. Rising interest rates could be disastrous for gold assets on the short term. However, on the long run rising interest rates will be good for safe-haven demand as rising interest rates could trigger large shocks the capital markets used to and dependent on the low interest rate environment. The FED also knows this risk could counteract all the repairing liquidation of the last year following the corona outbreak, therefore the FED is in a split.

Ten-Year Treasuries Have Stopped Rising

The ten-year U.S. Treasury bonds were rising in 2021 towards a high of 1.6%, but have cooled down since. Large investors seem to confirm the transitory story of the FED as the ten-year bonds are currently trading at a maturity rate of 1.44% following the FED’s meeting. However, the FED’s effective funds rate did rise from 0.06% to 0.10% on Wednesday, crawling towards to upper-side of the 0% – 0.25% bandwidth. But prior the interest rate hikes the FED must stop their continuous quantitative easing, which could have side effects that would undermine the maximum employment goal that the Federal Reserve has been pursuing since the beginning of the corona pandemic. Wells Fargo & Co. (WFC) have predicted that the ten year yield could soar as high as 2.2% when inflation does not fade over the summer. In such a scenario the Federal Reserve will not only come under pressure due to the rising inflation, but will also feel pressure by the Biden administration to continue their quantitative easing efforts, as the Democrats are spending more than ever and will most likely want to continue doing so. Interest rate hikes would be disastrous to stock markets, but also to Main street. The first signals of an economic slowdown in China point towards a more bearish scenario up ahead.

Figure 2 – 10-Year Treasury Rates

After a harsh sell-off in gold equities this week investors might want to reconsider buying gold at these levels. A hawkish FED could mean a painful liquidity drought which can lead to firm sell-offs in all markets. However, after such a sell-off gold equities are most likely to benefit from increased safe-haven spending. Therefore, buying the dip in gold assets could be wise even though potential short term losses. A Federal Reserve that has to choose between price stability and employment is a central bank that is in a split, which in most scenarios would be beneficial to safe-haven assets. On the short term financial assets could also benefit from the rise in interest rates. Volatility was up this week as markets saw their first big losses in months, while stocks like Virtu Financial (VIRT) and Flow Traders (FLOW) could benefit from the elevated uncertainty in markets. This week Michael Burry, Scion Asset Management leader known from the Big Short, warned individual investors for large losses in both crypto and meme stocks as leveraged trades are the first to get slashed when turmoil increases and liquidity fades. Despite high-inflation investors might want to consider larger cash positions to be able to rebalance once the real infliction point in central bank actions are made. In other words, The Golden Investor expects that hawkish decisions by central banks following better than expected economic growth could lead to lower markets. Hoarding cash is not necessary yet, but investors should be wary as markets increasingly look at the central bank’s decisions.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.

Leave a Reply