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When The Weight of Inflation Becomes Too Much 

Sep 14, 2023, 2:04 pm BST

In a comment to MarketWatch last week we said that traders this week would be most focused on the CPI report that came out yesterday. In that very report, Inflation came in hot, above expectations, and posted its biggest monthly increase in August this year. It’s up 3.7% from a year ago. However, markets didn’t seem so fussed. The release did prompt them to make a sort-of gesture of a reaction – stock market futures initially fell back but soon recovered and had a choppy sort of day. 

Unsurprisingly, Treasury yields were higher as a result of the report. As we discussed in last week’s post, this kind of performance is proving to be poor for both gold and silver. A strong US dollar and high Treasury yields win the opportunity cost equation when it comes to which liquid assets one should hold in the short-term. 

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However, as we also explained last week inflation still remains. The reason the US dollar and yields are so high is because of inflation. It is perverse given we all know what inflation really means for a currency, the economy and its citizens. However, this is a short-term phenomenon in the grand scheme of things. 

Headlines yesterday reported that transportation was one of the biggest victims when it came to inflation. This was largely blamed on oil prices. Whilst oil price hikes have slowed, the impact of a high price is yet to be fully felt in the economy. Wait until households feel the sustained increase in gas when filling up their cars week after week. How does that play into their inflation expectations? And how long before increased production costs feed into core inflation?

A heavy analogy

Not only that, but whilst economists congratulated themselves that the likes of goods and rents continue to disinflate, the harsh truth is that other key areas are still experiencing price rises – see healthcare and household furnishings as an example (h/t Omar Sharif, Inflation Insights). The spread of inflation is becoming broader, which in the short-term can make it feel like it’s less impactful. 

I like to think of it like an elephant wearing shoes (bear with me). When energy prices shot up (blamed on Russia) it was like an elephant wearing a stiletto had stood on the global economy.

It was a very focused pain source. However, as the impact of terrible monetary policy, financial crises, pandemics etc has come to fruition, it’s now like the elephant is wearing trainers and standing on the economy. The weight is the same but the spread of the weight is across a broader area. So the pain feels significantly less. 

But what happens as the elephant gets comfy? There’s only so long you can cope with an elephant standing on you – whatever kind of shoes they’re wearing. 

Next week is the FOMC’s September meeting. No one is expecting much drama. Throughout the summer Fed members have been expressing their commitment to the inflation fight, citing the need to keep rates higher for longer. 

I highly recommend you grab a coffee and have a listen to my 13 minute interview with chart expert, Gareth Soloway. On Tuesday he outlines why he’s impressed by gold amongst the US dollar strength and why he considers this to be the Bad News is Good News part of the cycle. He also gives us his thoughts on silver (more about that next week). 

Expect $2,500 – $3,000 Gold In Next 12 Months

ECB meeting

More interesting today though is the ECB meeting. There was no doubt some hot debates going on amongst members. The Eurozone is expected to continue to overshoot its 3% inflation target, into next year. Members must have been asking themselves if they should hike to try to combat this? Is this wise given all signs look oddly recession-shaped? The Committee found itself in a coin toss of a decision and neither face is one that you want to risk right now. 

As it turns out they decided to hike rates to an all-time high of 25bp, to 4%. Unsurprisingly the Euro fell against the dollar. This is without question the ECB’s most significant decision in over a year. It indicates that the ECB is more worried about inflation staying above target than they were about a recession. 

Had the ECB decided to keep rates as is then markets may have considered it to be a sign of a weakness in their commitment to fight inflation. However, the decision to hike rates to an all-time high will also make markets nervous as the ECB may have just made what is almost certainly a guaranteed economic downturn, even worse.

Where does that leave us?

So where does that leave things? Nowhere we haven’t been before. Central bankers continue to grapple with inflation, to bring it down to an arbitrary level. An exercise in self-flagellation if there ever was one. 

With their meetings, press conferences and endless models, central bankers seem so convinced that there is a cookie cutter approach here. That they can use models and predictions to help them solve this crisis. But history shows us that life and economics are unpredictable and open-ended. There is no ideal solution here. A few groups of people are trying to make decisions based on pretty skewed models with data that isn’t always reflective of the right now, and certainly not the future. 

With this in mind we carry on. We add gold to portfolios and we continue to admire its strong position this year. It’s been remarkable given the US dollar and Treasury yields. So stand firm and ignore the noisy central bankers and data releases. 

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