FXA rode the economic tailwinds to a breakout for a 15-month high.

Data from the Australian Bureau of Statistics (ABS) suggests that the unemployment rate has likely peaked at October’s 4.4% with December’s reading at 4.1%.

Even more important for monetary policy, the consumer price index (CPI) in Australia is above the RBA’s target 2-3% range. After dropping as low as 1.9% last year, the CPI suddenly rebounded above the RBA’s target range. Improving economic numbers will thus threaten to keep inflation higher than target if the RBA does not pivot to a tighter policy stance.

And then there are commodities, the core of Australia’s economy. Companies like iron ore producer Rio Tinto have enjoyed strong rallies to start the year as investors wake up to the economic realities of massive infrastructure and energy investments to support the AI boom along with the increasing attractiveness of physical assets as major countries pile on more and more debt. I started accumulating RIO in October and included the stock on my shopping list for 2026. So far, the price action has yet to deliver any kind of buyable dip. The strength of these commodity plays suggests that commodity-rich economies are going to experience upward pressure on their currencies. The breakout in RIO aligns well with the breakout in the Australian dollar.

Conclusion

All signs point to continued strength in the Australian dollar. A pivot in monetary policy will all but confirm a bias higher for the currency. Moreover, Australia looks relatively more attractive as a country versus major economies like Japan and the U.S. where policy and political turmoil along with mounting debt levels could keep those respective currencies under constant pressure. My main question now is how and when will fresh buying opportunities come.

Be careful out there!

Full disclosure: long FXA

The post Australian Dollar Breaks Out As Economic Winds Blow Toward Rate Hikes appeared first on Inflation Watch.

While it is far from clear how tariff-driven price hikes will eventually shake out, the Fed districts offered sufficient evidence of businesses who have price hikes waiting in the wings.

In Boston, a clothing retailer retagged products for sale this summer with higher prices than planned before tariffs.

In New York, manufacturers claimed they plan to pass along most or all of tariff-driven price increases. Moreover, “businesses continued to expect substantial increases in input prices in the months ahead.”

In Philadelphia, “more than two-thirds of the surveyed firms anticipated increased costs and expected their competitors to increase prices in as little as two months.” Yet, about half of Philadelphia respondents reported increased price sensitivity amongst its customers.

In Cleveland, businesses expect a “strong pace” of growth in costs”, particularly with nonlabor input costs rising “at a robust pace in recent weeks.”

Firms in Richmond expect prices to rise faster in the coming 6 months.

In Atlanta, some firms pushed through price increases despite softening demand, a troubling prospect of potential stagflation. Most interesting are the firms using “a multi-pronged approach to managing tariffs, including pushing costs back to suppliers, reconfiguring supply chains, absorbing costs in margins, and passing costs through to customers.”

In Chicago, businesses expect higher inflation over the next 12 months.

In St. Louis, “most contacts expecting nonlabor costs to increase next quarter reported that they would pass along the costs to customers within three months.”

In Minneapolis, more than half of surveyed business claimed they plan to increase prices in the coming future.

Kansas City businesses “generally [anticipate] higher input and output prices in the coming months.” Cost increases from the surge in demand for shipping products ahead of tariffs will be passed on to customers in the next 12 months.

Oilfield services firms in Dallas are having trouble passing along higher costs to customers. Of the Texas businesses who feel able to pass along tariff-related costs, “about 60 percent are doing so within a month of the tariff taking effect, and 90 percent are doing so within three months.”

San Francisco did not provide anecdotes or data on planned price hikes. However, one alarming anecdote came from a business which noted that tariff-related price hikes were not rolled back along with the related rescinded tariff. This inflation “stickiness” is a worrying indicator of how tariff-driven price hikes can cause lasting, cascading price pressures in the economy.

Given these consistent and confirming anecdotes and data points, the CPI looks set to bottom out in coming months if not in the very next report. With Beige Book in hand, the Fed is unlikely to cut rates ahead of more certainty on tariff policy. These reports from the Federal Reserve’s districts underline Jerome Powell’s core desire to see the economic warfare, primarily through tariffs, come to an end.

The Downtrending CPI Is Also Colliding With A Weakening U.S. Dollar

While May’s CPI came in softer than “expected”, its descent still slowed since March’s big drop. The reports from the Beige book suggest that this downtrend could continue if not for tariff-driven price pressures. Instead, fresh inflation agitation likely awaits.

Source: U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis. June 12, 2025.

In the meantime, the U.S. dollar continues to weaken. At the time of writing, the U.S. dollar index (DXY0) briefly broke down below its 3-year low set back in April. A weaker dollar means imported goods become more expensive, all else being equal. Thus, the weaker currency will translate into higher inflation in the U.S. except to the extent demand for imported goods falls along with the dollar.

Source: TradingView

Be careful out there!

The post A Calm Before Fresh Inflation Agitation? appeared first on Inflation Watch.

Tariffs Create Inflation Risk

While the administration goes back and forth on whether tariffs will create price increases, Powell is quite clear: “If the large increases in tariffs that have been announced are sustained, they are likely to generate a rise in inflation”. Powell further warned that these large tariffs will also likely lead to “a slowdown in economic growth, and an increase in unemployment”. This cocktail is the very definition of stagflation. Powell reinforced his implicit plea to end the tariff war by repeating his warnings during the Q&A session. For example, he emphasized that “given the scope and scale of the tariffs…certainly the risk to higher inflation, higher unemployment have increased.” As a result, the Fed “won’t see further progress toward our goals, but we might see a delay in that.”

To add credibility to the concerns, Powell referenced the consensus (emphasis mine): “If you look at where forecasters are, they’re all forecasting an increase in inflation.” Without admitting he fears the potential of a recession, Powell followed up by referencing “forecasts of weakening in the economy and some have recession forecast.”

Thus, if Powell was in charge of trade policy, he would not go down the current path of large tariff increases. The risks to inflation and of a weaker economy – aka stagflation – are too great.

These admonishments are made more remarkable given the on-going (and one-way) spat that President Trump has with Powell. Trump now calls the Fed Chair “too late Powell”. Trump piled on by calling Powell a fool after the latest stall on rate cuts. I suspect Trump sees the hidden messages in Powell’s commentary.

Waiting As Leverage

Given the standoff in risks, the Fed has no choice but to sit on the sidelines of policy. Firstly, the trade policies are uncertain and in flux. During the current 90-day pause, anything can happen, including a sudden collapse in the ceasefire or another 90-day pause to avoid all-out economic warfare. Once these uncertainties clear up, the Fed next must wait to see impact from the policies before it can venture to take action.

Yet, I think the Fed would be cutting rates if not for the tariff risks. During the Q&A, Powell let slip that the Fed could have been late in cutting rates last year: “I wouldn’t say that what we did last fall was at all preemptive. If anything, it was a little late.” Ironically, the tariff risks will definitely make the Fed late again. By the time the dust settles enough for the Fed to be confident in more rate cuts, the economy could be deep in the throes of weakness.

Still, there is an interesting angle in the Fed’s insistence on waiting. The U.S.’s massive budget deficits need to be financed at lower rates. This more favorable financing likely needs the assistance of the Fed, whether by coaxing the long-end of the bond market to come down with “follow the leader” federal fund rate cuts or something more direct like “Operation Twist.” The longer higher rates persist, the harder it will be for the U.S. to take major fiscal action like extending the massive tax cuts from 2017. Powell has insisted since the first pause on rate cuts that the Fed can afford to wait. In the latest meeting, Powell further emphasized the Fed can afford to wait. I counted 21 times Powell used the word “wait” or “await”, 3 times Powell referenced no need to “hurry”, and another 4 times Powell insisted on exercising patience. I see a Fed in stagflation planning mode when Powell insists “for the time being, we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.”

The message to the White House? Provide clarity post haste. All this waiting is the Federal Reserve’s way of exercising leverage while disavowing interest in advising on policy.

Markets React: The Dollar, Gold, and Bond Yields

After the Federal Reserve’s statement, the U.S. dollar strengthened, gold weakened, and long-term bond yields went higher for the rest of the week.

The U.S. dollar index (DXY) is still rebounding off a 3-year low. So for now I am assuming that the dollar’s strength for the rest of the week was a residual from this bounce from “oversold conditions”. Currency traders are likely waiting for the next dramatic tariff headlines to resume selling the dollar. (I currently hold a mix of long and short dollar bets). The weekly chart below shows that at the peak of the tariff trauma and drama that the dollar index reached a level last seen in March, 2022.

Gold is even more intriguing. The SPDR Gold Trust (GLD) went on a near parabolic run for a week and a half in April. Such runs usually come to climactic ends. In GLD’s case, a bearish engulfing topping pattern signaled the end of the run. GLD attempted a rebound from support at its 20-day moving average (DMA) (the dotted line below), but it stopped cold right at its all-time high. Fed day brought GLD right back down to its 20DMA support. I suspect this support will eventually give way as the Fed’s latest insistence on patience translates into a slightly lower enthusiasm in buying gold as a hedge against a Fed forced to cut rates right into the teeth of tariff-driven inflationary pressures. Waning enthusiasm is likely only worth a test of uptrending 50DMA support (the red line).

Long-term rates have chopped around since December. However, based on the “heavy” technicals for iShares 20+ Year Treasury Bond ETF (TLT), rates look poised to head higher at some point. TLT is just one more bout of economic chaos away from a fresh swoosh downward. The lows of the year coincided with levels last seen in November, 2023.

Stuck Until Further Notice

By the time of the next Fed meeting in June, we should have a better idea about the success or lack thereof for the 90-day tariff pause. The pressure will only increase on Powell to speak clarity into monetary policy. If more economic and sentiment indicators are flagging increasing stagflationary pressures while trade policy remains uncertain, I expect Powell to get more strident in his warnings (in Powell’s mild-mannered way of course). In the meantime, the stock market looks poised to join the Federal Reserve in getting stuck. The S&P 500 (SPY) is in a cliffhanger trading right below 200DMA resistance for the month of May.

Be careful out there!

The post Powell’s (Not So) Hidden Plea to End the U.S.’s Tariff War appeared first on Inflation Watch.

Shmid warned that “while in theory, tariffs may have only temporary effects on inflation (although persistent effects on the level of prices) I would be hesitant to take too much solace from theory in this environment”. He tied recent tariff announcements to broader signs of economic stress, including “a decline in consumer sentiment and increases in near-term inflation expectations.” Schmid acknowledged that the current policy environment has become “considerably more complicated,” citing feedback from business contacts who see growing risks on both sides of the Fed’s dual mandate of maximum employment and stable prices.

Schmid’s skepticism around transitory inflation contrasts with recent remarks from Fed Chair Jerome Powell, who has leaned into a more reassuring message about the persistence of tariff-driven price pressures. In “Jerome Powell’s Fed Deftly Maneuvers Through a Stagflationary Minefield“, I admired Powell’s effectiveness in navigating a difficult policy landscape, but I also pointed out the problematic use of “transitory” to describe inflationary effects. Powell argued that “it can be the case that it’s appropriate sometimes to look through inflation if it’s going to go away quickly without action by us… and that can be the case in the case of tariff inflation.”

That assertion paralleled Treasury Secretary Scott Bessent’s line that tariffs are a “one-time price adjustment.” But as I wrote in “The Sleight of Hand Behind the ‘One-Time Adjustment’ and ‘Transitory’ Tariff Inflation Narrative“, for inflation to be transitory, expectations for price levels would need to revert after the initial tariff shock. Yet, “tariffs make price reversion unlikely by locking in a permanently higher cost base.” In that piece, I also pointed out how structural effects – such as wage responses, supply chain disruptions, and embedded cost pass-through behavior – make inflationary pressures from tariffs more persistent. Outcomes are also hard to anticipate as inflationary pressures cascade through the economy.

Schmid appears attuned to these systemic effects. He described “a marked increase in the upside risks around inflation along with elevated downside risks to the outlook for employment and growth,” and openly questioned the prudence of discounting these risks as fleeting. Unlike Powell, who focused on optionality and emphasized that longer-term inflation expectations remain anchored, Schmid directly acknowledged that business sentiment and price expectations are shifting in ways that could prove difficult to reverse.

Powell’s message was strategically designed to preserve policy flexibility and calm markets in the face of stagflationary fears, and in that moment, Powell succeeded. However, I remain concerned that Powell’s framing underestimates the lasting damage that tariff-related cost increases can impose on the economy. As I wrote in my critique, the idea of a “one-time adjustment” may be statistically correct but economically misleading. A new, higher price level, once established, may not simply fade away. The higher price level could reshape business behavior and household expectations for years to come.

Schmid seems to understand these risks. His closing words underscore the seriousness of the moment (emphasis mine): “With renewed price pressures likely, I am not willing to take any chances when it comes to maintaining the Fed’s credibility on inflation.” That statement signals a shift away from the complacency that defines the transitory inflation narrative on tariffs.

The Last Friendly Report on Inflation?

As the Fed slowly accepts increased inflationary risks in the future, the past provides fleeting reasons for optimism on inflation. While I have stuck by the persistent and sticky narrative on inflation, March’s CPI (Consumer Price Index) report signaled the potential start of the next leg down for core inflation…just in time for tariffs to pressure inflation upward again. From the report:

“The index for all items less food and energy rose 0.1 percent in March, following a 0.2-percent increase in February. Indexes that increased over the month include personal care, medical care, education, apparel, and new vehicles. The indexes for airline fares, motor vehicle insurance, used cars and trucks, and recreation were among the major indexes that decreased in March…

The all items less food and energy index rose 2.8 percent over the last 12 months, the smallest
12-month increase since March 2021.”

Notably, the shelter index was up 4.0% year-over-year.

The chart below suggests that, absent tariff inflationary pressures, core CPI would finally be on its last leg lower toward the Fed’s 2.0% target.

Ironically, this positive development in core CPI could give more confidence to policymakers in pressing forward with inflationary tariffs.

Bostic Concurs

In an interview on Marketplace, president and CEO of the Federal Reserve Bank of Atlanta, Raphael Bostic, appeared to concur with Schmid’s concerns:

“I think the pressures that are out there are not the best for our mandates. All the models say that the introduction to tariffs is going to put upward pressure on prices, and I’ve seen more reports of recession fears in the media and from our business contacts than I’ve heard in a year and a half or two years. And so that’s also going to put pressure on our mandate, the employment mandate, in a way that is not positive.”

Bostic’s tiny source of solace is that “the current environment today might not be the current environment tomorrow.”

Currency Correction

Typically I conclude these inflation reviews by teasing out some implications and impacts in currency markets via the U.S. dollar. This time around, there are too many tariff-related cross-currents and too much economic chaos to directly connect dots. So, instead, I take this time to describe a “currency correction” I had to make on the Canadian dollar (USD/CAD) and the Mexican peso (USD/MXN).

A month ago I explained:

“I am short USD/MXN out of a belief that economic relations with Mexico are about as bad as they can get. I could of course get proven wrong in due time. On the other hand, I am long USD/CAD because I do not think the market fully appreciates how much weaker the Canadian economy will get as it tries to match the U.S. in this economic warfare.”

I was correct for almost two weeks, but in due time I have been proven wrong. I have now closed out both trades in order to reassess my next moves. Surprisingly, the Canadian dollar has proven quite strong against the Mexican peso. The exact opposite of my expectations. That chart below shows how CAD/MXN is breaking out from an approximate triangle or wedge type pattern.

Even more importantly, USD/CAD has broken below a key support level at the same time the U.S. dollar looks poised for a fresh, major breakout against the Mexican peso. In other words, in the last 2-3 weeks, I could not have been more wrong! (Note how the 25% tariff on Canada and Mexico defined a PEAK for USD/CAD, a classic contrarian move).

While USD/CAD broke support at its 200-day moving average (DMA) (the blue line), USD/MXN HELD 200DMA support. Thus, USD/MXN looks likelyly to head even higher while USD/CAD looks likely to head even lower.

This currency correction took me by surprise. The move likely reflects the effectiveness and the robustness of Canada’s current resistance to U.S. economic warfare. Mark Carney, the new Prime Minister of Canada, has been quite clear in laying out a framework of Canadian resistance. The Governor of the Bank of Canada, Tim Macklem, has been similarly forthright in laying out the implications for monetary policy and bracing Canadians for the economic warfare ahead. Apparently, both men have, so far, succeeded in bolstering Canada’s defenses (symbolically through the Canadian dollar). The implications for inflation both here and in Canada remain to be seen as trade slows down between the two North American neighbors and former allies.

Be careful out there!

Full disclosure: no positions

The post Inflation Concerns Rise at the Federal Reserve Amid Tariff Unease appeared first on Inflation Watch.

However, a systemic perspective greatly weakens claims of a one-time adjustment. Over time, tariffs can create a cascading effect through the economy, especially when tariffs are broadly applied across a wide swath of goods and services. Over time, tariffs can embed and entrench inflationary pressure in the economy from the following:

• Wage pressures – workers may demand higher wages to compensate for persistently higher consumer costs.
• Supply chain adjustments – companies may shift to more expensive domestic or alternative suppliers.
• Cost pass-through effects – producers adjusting pricing behavior in response to permanently higher costs as they enjoy greater pricing power amid a reduction in alternatives.

Moreover, successive rounds of tariffs, as the economy is experiencing now, amplify inflationary ripple effects, making them harder to unwind.

Still, that one-time adjustment is higher and persistent. So I am skeptical as Bessent also tries to resurrect “team transitory” when explaining the impact of tariffs. For inflation to be transitory, price levels would need to revert after the initial tariff shock. Tariffs make price reversion unlikely by locking in a permanently higher cost base unless offset by productivity gains, currency shifts, or supply chain innovations. Again, all else being equal, as long as the tariff is in place, someone is paying the cost, this year, the next year, and so on. The price increase will not disappear on its own accord. If you are still complaining about how much higher prices are now compared to 2019, you will find yourself complaining years out about the higher prices brought on by tariffs passed on to the consumer level.

Can pandemic-era inflation be described as a one-time adjustment? Of course. All we need to do is extend the time period over which “one-time” applies. The chart below shows the year-over-year change in the average annual CPI. Even if inflation slows to its pre-pandemic pace by 2026, the accumulated price increases remain, permanently raising the cost of living (of course, I have my doubts about the pace of inflation’s decline given the underlying stickiness of key inflationary components). In 2027, a casual observer could look back and conclude this inflationary era was a one-time price adjustment that lasted about 5 years. While the conclusion would be technically correct, the broad price level remains significantly elevated, straining household budgets long after the inflationary event passes. In other words, a “one-time adjustment” in this context is only academically meaningful.

Source: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis; March 7, 2025.

Terms like “transitory” and “one-time adjustment” do not speak to the direct and real-time impacts on consumers. These terms are sleights of hand to convince financial markets to look through the price dynamics. Consumers cannot look through these impacts. They must immediately adjust spending habits to account for the deterioration in spending power from tariffs, especially broad based ones (all else being equal).

Adjustments and Transitory Effects In Currency Markets

In foreign exchange, the Canadian dollar and the Mexican peso have served as ground zero for the current chaos over ever-changing policies on tariffs and economic warfare. However, overall, against the U.S. dollar, these currencies have stuck to a well-defined trading range. Against the U.S. dollar, the peso was trading at these same levels four months ago with a 5% trading range from bottom to top (excluding outliers). Against the U.S. dollar, the Canadian dollar was trading at these same levels three months ago with a 2.6% trading range from bottom to top (excluding outliers). On the biggest single-day of volatility, the day tariffs were delayed for a month right before they were scheduled to take effect, USD/MXN traded through a 4.7% range and USD/CAD traded through a 2.8% range. In other words, both currencies covered their entire range of volatility in one day.

These percentages are large in foreign exchange. The adjustments can be seen in the persistently elevated levels for both USD/MXN and USD/CAD. There is no transitory observation until the volatility dies down and/or the price adjustment itself reverses. In the meantime, I am short USD/MXN out of a belief that economic relations with Mexico are about as bad as they can get. I could of course get proven wrong in due time. On the other hand, I am long USD/CAD because I do not think the market fully appreciates how much weaker the Canadian economy will get as it tries to match the U.S. in this economic warfare. Combined, these two trades are good pair trades where I collect interest income from USD/MXN as I wait. Week-to-week volatility in USD/CAD allows me to execute a few swing trades.

Epilogue

Last week I spent more time understanding the economic theories and frameworks espoused by Bessent. The interview at the Economic Club of New York with Larry Kudlow was educational in that respect. Unfortunately, the recording started after the commentary on tariffs. Minus the cheap shots, the rest of the interview is worth watching and understanding.

Be careful out there!

Full disclosure: long USD/CAD, short USD/MXN

The post The Sleight of Hand Behind the ‘One-Time Adjustment’ and ‘Transitory’ Tariff Inflation Narrative appeared first on Inflation Watch.

The chart below from the Surveys of Consumers – University of Michigan shows another interesting element of the inflation story. Long-term consumer expectations for inflation have remained elevated since the pandemic. The surge in short-term expectations may be strong enough to push longer-term expectations into breakout territory.

Source for Data: the Surveys of Consumers – University of Michigan

The latest spike in inflation expectations may soon cool off like the previous ones, but I do not expect the downtrend to resume from there given the current macroeconomic and policy environment. For example, as tariff talk translates into action which in turn translates into higher prices, I fully expect inflation expectations, at least short-term, to rise above current levels.

A Tired and Topping Dollar?

Interestingly, for all the talk about how tariffs will boost the U.S. dollar, the greenback is now down for the year and looks like it will continue trending downward. The Yale Budget Lab explains how the dollar strengthens from tariffs when there is no retaliation. When countries retaliate, their domestic demand for U.S. goods may decline and as a result demand for U.S. dollars declines. Could it be that the currency market is starting to wrestle with a net impact on the dollar from tariff wars just as consumers are starting to fear inflationary impacts from tariffs?

The U.S. dollar index (DXY) topped out in mid-January and is now down 1.7% for the year. (Source: Tradingview.com)

Canadian Resistance

Perhaps the volatile action against the Canadian dollar is instructive. When I last wrote, I explained why I decided to take profits on a long USD/CAD position. That exit turned out to be timely. Just two days later, USD/CAD surged right to resistance from the double-top formed across 2016 and 2020 highs and quickly reversed. President Trump created wild currency volatility by announcing tariffs on Saturday, February 1, and then reversing two days later with a 30-day “pause” following concessions from Canada. During this episode and in its wake, an active “Buy Canadian” movement has taken hold. If tariffs are re-enacted I expect vigorous retaliation from Canada. In other words, the dollar’s rally against the Canadian dollar may have indeed peaked on February 3rd with the blow-off top.

USD/CAD broke down below support at its 50-day moving average (DMA) (the red line above) and could be on track to eventually reverse all its gains from November’s big breakout. Source: TradingView.com

Having said that, I am not yet ready to short USD/CAD. I am actually long again preparing for the possibility of one more rally (to the 50DMA or maybe even challenge the high?) before USD/CAD confirms its top. My long USD/CAD is also a small hedge against other bets against the dollar.

Be careful out there!

Full disclosure: long USD/CAD, long SPY put spread

The post Inflation Expectations Surge As the U.S. Dollar Tops Out appeared first on Inflation Watch.

For three months, the bond market has flagged stabilizing inflation starting with the Fed’s first rate cut of 50 basis points (bps). The stock market continued to rally along its uptrend lines. In parallel, the Federal Reserve signaled its second thoughts about its benigas n projections for inflation in the September Summary of Economic Projections. The stock market failed to listen and even Fed fund futures insisted on forcing the Fed into a December rate cut. The Fed delivered that rate cut with a major caveat in the December Summary of Economic Projections: hotter forecasts for inflation and economic growth and an incrementally hawkish expectation for future monetary policy rates. Accordingly, the Fed finally got the stock market’s attention as the market essentially plunged from euphoria to oversold in one day.

Long-term yields continued to increase the day of the Fed decision and the following day. The iShares 20+ Year Treasury Bond ETF (TLT) sliced right through presumed support and closed right at the low for the year set in April.

I took profits on my latest round of TLT put options last week. I will not chase TLT down here. Instead, I will wait to fade the next relief rally.

Instructive Projections

The Fed’s changes were significant but consistent with the Fed’s smoke signals and the declines in the long-term bond market.

• 2025 PCE inflation of 2.3-2.6% vs. the 2.1-2.2% September projection
• 2025 federal funds rate of 3.6-4.1% vs. the 3.1-3.6% September projection
• 2025 GDP 1.8-2.2% vs. the September projection of 1.8-2.2%

Fed Chair Jerome Powell’s commentary during the press conference was instructive. Powell left no question that the Fed sees higher inflation ahead: “these median projections are somewhat higher than in September consistent with the firmer inflation projection.” He acknowledged that under-estimating inflation this year was a partial driver of higher 2025 expectations: this year’s projections have “fallen apart as we’ve approached the end of the year”. Yet, Powell also laid the foundation and rationale for keeping a bias toward easing. He pointed reiterated that the labor market is no longer contributing to inflationary pressures and its accompanying cooling has gone far enough. Moreover, activity in the housing sector has been “weak”. Accordingly, Powell claimed that “cuts will certainly help to support economic activity and the labor market while we can still make progress on inflation because policy is still meaningfully restrictive.”

I remain skeptical. Is current policy really “meaningfully restrictive”? In his opening statement, Powell declared “with today’s action we have lowered our policy rate by a full percentage point from its peak and our policy stance is now significantly less restrictive. We can therefore be more cautious as we consider further adjustments to our policy rate.” This claim only weakly translates into “meaningfully restrictive.” Moreover, financial conditions are now almost as loose as they have ever been since the pandemic per the Chicago Fed’s Adjusted National Financial Conditions Index (ANFCI).

Sure, as one reporter in the Q&A pointed out, “we haven’t seen much change in mortgages, auto loan rates, or credit card rates.” Still, the conventional measures of financial conditions are about as good as can be in the post-pandemic era. Thus, the Fed is walking a fine line between the fear of restoking firmer than expected inflation and a labor market that is noticeably cooling. In the middle, the stock market is pricing in a perfect resolution to this dilemma even with the current plunge.

Powell’s Inflation Narrative Still Rests With the Pandemic

At several points during the Q&A portion of the conference call, Powell offered his version of inflation’s recent history, its origins and drivers. I was surprised to hear him claim that the economy is still dealing with pandemic-related disruptions that are propping up inflation. Perhaps this was a thinly veiled attempt to excuse this year’s under-appreciation of inflation’s stickiness. Powell also blamed technical factors for inflation’s stickiness: the way housing rents are calculated, lags in the data, and “temporary factors like fluctuations in used car prices.” As usual, I turned a skeptical ear toward this narrative because Powell, as he consistently does, absolved the Fed of any responsibility in aiding and abetting inflation’s stickiness by keeping rates too low for too long. I reviewed the case for why the Fed should have raised earlier in “Why Monetary Policy Was Late In Responding to the Pandemic-Era Inflation Surge“). At least this year’s experience and the learning response suggests the Fed will be more circumspect. Victory over inflation is not quite at hand yet.

The Fiscal Wildcard

Circumspection and caution should be keywords going into 2025 and beyond given the uncertainties in fiscal policy. A deepening tariff war and significant tax cuts threaten the Federal Reserve’s fragile dance with inflation-fighting. The mix of opinions within the Fed are telling. In describing how individual Fed members incorporated fiscal policy risks into their forecasts, Powell responded that some members chose to try to estimate fiscal impacts, some chose to leave out fiscal impacts, and others chose not to indicate whether they included fiscal policy. That is quite a mix! Powell made it sound like people stubbornly constructed their forecasts. Anyway, this inconsistency means that the reality of fiscal actions could drive inflation estimates even higher and cause even greater caution at the Fed.

King Dollar

The U.S. dollar (DXY) was the big post-Fed winner. Fresh strength in the U.S. dollar drove the Invesco CurrencyShares Euro Currency Trust (FXE) to a new 2-year low. This breakdown sets up FXE to eventually retest the lows from 2022. Accordingly, I am finally fully on the strong dollar bandwagon. I also expect the stock market to struggle to hit new all-time highs while the U.S. dollar makes new highs.

Is the Invesco CurrencyShares Euro Currency Trust (FXE) ready to resume a downtrend that started in earnest during the financial crisis?

YouTube video of the December 18th FOMC Press Conference

Be careful out there!

Full disclosure: long SPY put spread

The post The Federal Reserve’s “Hawkishness” Finally Gets the Stock Market’s Attention appeared first on Inflation Watch.

The stock market woke up the next day after the Producer Price Index (PPI) came in hot and suggested once again that underlying price pressures in the economy continue to increase. The S&P 500 gapped down and lost 0.5%. More importantly, TLT lost another 1.2% and confirmed a breakdown below its 50-day moving average (DMA). The core PPI, Final Demand Less Foods and Energy, has trended upwards all year and is now at its highest level since February, 2023 at 3.5%.

Source: U.S. Bureau of Labor Statistics, Producer Price Index by Commodity: Final Demand: Final Demand Less Foods and Energy [PPIFES], retrieved from FRED, Federal Reserve Bank of St. Louis, December 12, 2024.

Assuming the Federal Reserve cuts rates next week as expected, I am guessing rate cuts will slow to a crawl if not come to an outright halt for the beginning of 2025. Accordingly, the Fed’s communications to the market will get about as tricky as ever. Fortunately for the bulls the market’s momentum carries a large amount of buffer from current Animal Spirits.

iShares 20+ Year Treasury Bond (TLT)

The fascinating contrast between stubbornly stable inflation and Fed rate cuts continues to keep me fading rallies in TLT. TLT’s earlier breakout above its 50DMA (the red line below) almost fooled me. TLT is now closing the gap up created by Trump’s pick to head the U.S. Treasury department, Scott Bessent. Assuming that gap closes, a true test of the bottom of the presumed trading range should finally unfold.

Gold

While TLT delivered, gold disappointed. I have a live short-term trade in PHYS and call spreads and call options in SPDR Gold Trust (GLD) that orbits my core long-term position in GLD shares. I was encouraged by GLD’s reaction to the CPI and just assumed the rally would continue into at least the end of this week. Instead, GLD reversed right back to 50DMA support. I do not have a ready hypothesis to explain this seemingly contrarian move. (I would love to hear yours!)

What Happens If the Fed Gets “Hawkish”

The Fed is currently dovish. It would not take much for the Fed to sound hawkish. A firm follow-up to the round of Fedspeak attempting to walk back market expectations for rates cuts could set off the alarm bells for the market. At that point, the short-term GLD trade gets less attractive. TLT will probably still be good for fades. The stock market will likely stall for at least the rest of the Santa rally season….just enough time to find the next reason to reinflate Animal Spirits.

The big wildcard for me in a “more hawkish Fed” scenario is the U.S. dollar. There are multiple countervailing catalysts that make the U.S. dollar attractive and unattractive. Thus, it is hard to develop conviction beyond the short-term technicals. Right now, I still like fading the euro against the U.S. dollar. At the same time, I finally gave up trying to catch a pullback in USD/CAD, a strengthening in the Canadian dollar (Invesco CurrencyShares Canadian Dollar Trust (FXC)). I am now playing the major breakout to the long side. USD/CAD is practically making a beeline to test a critical long-term double-top spanning 2016 and 2020.

Be careful out there!

Full disclosure: long USD/CAD, short EUR/USD: long GLD shares, calls, and call spread; long PHYS, long TLT puts

The post Bonds Try to Weigh on A Market Trying Harder to Look Past Stabilizing Inflation appeared first on Inflation Watch.

The chart below shows the change in PCE in the red (and lower) line. The change in the CPI is in the blue (and higher) line.

Sources: U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis, October 10, 2024. U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis, October 10, 2024.

Who is paying attention to the stabilizing trend n core inflation? The stabilization started ahead of the Fed’s 50 basis points rate cut on September 18th. The giddy anticipation of that rate cut dominated sentiment. Since then, the market has become relatively more certain about a 25 basis point cut in November.

Long-term bod yields fell going in to the Fed meeting but have since shot nearly straight up. Same for the U.S. dollar. The iShares 20+ Year Treasury Bond ETF (TLT) fell again in response to the CPI report, and the U.S. dollar gained marginally. So the bond and currency markets may start anticipating a longer-lasting stabilization trend. Note how TLT has come straight down except for a one week pause above support at its 50-day moving average (DMA) (the red line below).

Source: TradingView

During this time, the U.S. dollar index (DXY) first bottomed and then shot straight up for much of October.

Source: TradingView

While both shorting bonds and going long the dollar have been profitable trades, the most interesting trading action sits with the S&P 500 (SPY). Despite rising long-term bond yields, the index managed to break out to a fresh all-time high. The September CPI report barely knocked the index off its all-time high. The S&P 500 seems to have a mind of its own and is hardly paying attention to much at all over time. Even the recent increase in the volatility index (VIX) has barely fazed the S&P 500. Moreover, this strengthening bullish appearance is happening during a time which represents the third of the stock market’s most dangerous months.

Source: TradingVIew

In other words, while stabilizing inflation could dampen the trajectory for rate cuts, the S&P 500 seems to be on a near one-way track higher going into the November Presidential elections and year-end. Cause and effect across financial instruments seems quite muted. Or maybe stock traders and investors are straining to make the case that stabilization will soon give way to a resumption of a downtrend in inflation. Either way, it is not clear who is paying attention to stabilizing core inflation.

As long as these broken correlations persist, I prefer to just follow the current trends: fade TLT rallies, buy dips in the U.S. dollar, and, yes, buy the S&P 500 (I am currently hedged with a SPY put spread).

Be careful out there!

Full disclosure: net long the U.S. dollar, long SPY put spread

The post Who Is Paying Attention to Stabilizing Core Inflation? appeared first on Inflation Watch.

These graphs show a clear victory over inflation. Still, the 70% confidence interval remains wide over a range from close to 0% to 4%.

Gold Disagrees

Gold disagrees with the Fed’s inflation victory. Gold bugs are likely staring at the top end of the PCE confidence range (or even higher!). Gold is the most interesting contradictory signal for the Fed’s victory because it has easily outperformed the S&P 500 (SPY) this year. The SPDR Gold Trust (GLD) is up 26.7% year-to-date; this performance well outpaces the S&P 500’s 19.6% gain for the year. Gold can of course gain favor for a variety of reasons, but as long as rates are trending downward, I expect gold to continue higher. Notably, GLD bounced back sharply after its initial post-Fed fade and closed last week at a fresh all-time high.

The Wary Bond Market

The bond market looks a little wary about the Fed’s presumed victory. The iShares 20+ Year Treasury Bond ETF (TLT), which goes up when long-term interest rates go down, rallied into the Fed’s announcement on monetary policy. However, TLT gapped down ahead of the news and closed lower. TLT continued lower the rest of the week. It is possible the bond market got ahead of itself in anticipating economic weakness and/or lower inflation. Either way, I am looking at the technicals of TLT and see the confirmation of a (horizontal) presumed trading range. This trading range is working against the steep uptrend in the 20-day moving average (the dotted line in the chart below) and the 50-day moving average (the red line in the chart below). Thus, some kind of trend change or resolution is likely on the way in coming weeks. The outcome may sway my interpretation of the Fed’s inflation victory.

Bowman Disagrees

Both gold and the bond market could even take cues from the one dissenting voice on the Fed. On Friday, Governor Michelle W. Bowman explained why she only wanted a 25 basis point cut: “We have not yet achieved our inflation goal.” In particular, Bowman worries the 50 basis point cut “could be interpreted as a premature declaration of victory on our price stability mandate.” Bowman is not ready to declare victory.

The next Fed meeting is not until November. There is a lot of time ahead for Fedspeak to lean against any excessive victory celebrations in the financial markets. I will keep an interested eye on the market’s reaction to sobering words of caution and restraint.

The U.S. Dollar Hangs in the Balance

The Fed’s implied victory over inflation is also the U.S. dollar’s loss. The Fed is a bit late in lowering interest rates relative to several of its peers. The European Central Bank (ECB), the Bank of England (BoE), and the Bank of Canada (BoC) each dared to lower rates ahead of the Fed’s move. Yet, currency markets stayed keenly focused on coming rate cuts from the Fed such that the U.S. dollar weakened against each of the related currencies even as other banks fell one-by-one.

The British pound, Invesco CurrencyShares® British Pound Sterling Trust (FXB), benefited the most from dollar weakness of the currencies that are in the middle of rate cut cycles. Last week, FXB broke out to a fresh 31-month high. The weekly chart below shows FXB has room to recover back to its highs from 2021. Such a run is in the cards if Fed rate cut expectations continue to point lower.

I want to get more bullish on the Canadian dollar, but Invesco CurrencyShares® Canadian Dollar Trust (FXC) barely shows signs of life. FXC is scraping along a bottom that has served as support since the lows of 2022. If FXC hurdles over the previous weekly high, I will get more constructive. In the meantime, it seems the Canadian dollar is captured by a fate similar to the U.S. dollar (DXY).

The Victory Trade

So far, the Fed’s victory over inflation looks like victory for gold and the British pound. The story from the stock market is mixed. While the S&P 500 is back to an all-time high, the NASDAQ remains below a bearish topping pattern. Small caps are languishing. I do not expect the story to get clearer during October given its reputation as one of the stock market’s most dangerous months. Thus I am (short-term) neutral on the stock market as a whole while I remain (perma) bullish on gold. Gold is my inflation victory trade.

Be careful out there!

Full disclosure: long GLD, long SPY put spread, long QQQ put spread, net long USD

The post What A Victory Over Inflation Looks Like to the Federal Reserve appeared first on Inflation Watch.