I posted yesterday that this morning’s CPI release would be an “order of magnitude” more significant for markets than the midterm seasonality financial media were touting, and a little victory lap is in order. The CPI came in at 7.7% yoy versus expectations of 7.9%, good for a thousand point surge in the Dow Jones Industrials. But as good as the portfolio numbers feel, the economic implications are nothing to celebrate. Yes, it does confirm my long held view that the Fed is making meaningful progress on quelling consumer price inflation, but the rally the media are so keen to celebrate represents a decline in the market value of the dollar, at cross purposes with reducing consumer price inflation going forward.
The irony of celebrating progress on inflation with a renewed burst of inflation should be lost on no one.
Dollar denominated price increases affected assets across the board. Not only did stock prices rise, but Treasury prices soared, oil surged, copper spiked, silver, platinum, gold, foreign stocks, foreign currencies … which as I have pointed out ad nauseum, can mean only one thing … the market value of the one thing they all have in common – the chosen measuring unit – USD – fell. This is exactly what the Fed does not want to see in its effort to tame inflation. As it has come to recognize, the loss of currency value reflected in rising asset prices prefigures its loss in rising consumer prices.
So while the immediate effect has been to increase market odds of a 50 bp hike in December at the expense of a 75 bp hike, it merely represents a time shift in the distribution of hikes. While it is still possible the Fed will hike 75 bp December 14 (there is still quite a bit more data to be released by then), the effect on the “terminal rate” is de minimus. I would prefer the FOMC hike 75 bp in December and then enter wait-and-see mode, but more likely we’ll see 50 in December and 25 in January. The resultant 4.50% floor is the same either way, and it really makes little difference whether it’s achieved via 75 or 50+25 bp.
This dollar collapse – asset price surge however negates all of the anticipated net easing benefit that the softer-than-expected CPI might have reflected.
As far as our market outlook goes, it appears my comment of October 27 about the bond market inflection is being vindicated. Treasury bonds bottomed on October 24, scarcely three weeks after the October 1 date Synthetic Systems had pegged. Not bad for a turn that it had called as long as two years ago. Yet our trophy is tarnished a bit by the failure of stocks to decline in opposition … in other words it’s still all about the dollar … the divergence between stocks on one hand and bonds and gold on the other remains elusive.
Best assessment at this point is that while it could still come this quarter, it could just as easily be deferred into next year. The lagged effects of the increases in rates and yields are nearly certain to produce a “recession” (which due to the fuzzy and unmeaningful for investors way conventional economics defines it, I will define to mean a “recession” in stock prices). The Fed will be cutting rates, bond yields will decline, bond prices will rise, and gold prices will rise. What I do not expect, however, is for the path to be smooth. Rather it will be lumpy … the anticipated outperformance of gold and Treasuries over the next few quarters will come in chunks as stock rallies such as the one we’re seeing now punctuate periods of sharp selloffs, with both bonds and gold likely rising not only relative to stocks but in dollar terms as well. In other words, it won’t be about the dollar any more … the period of unusual dollar strength is likely behind us and the fondness for cash I have cited for most of this year is as well.
So for bonds, the bear market that began in mid-2020 appears to be over. The bear market in gold, which appears to have bottomed on November 3, likely is as well. I believe these are each beginning a new bull market.
For stocks, the bear market continues. Meanwhile … enjoy the halftime show!