“A strategy of repeatedly lowering the fed funds target range toward a more neutral level relies on confidence that the neutral level is materially lower than where rates are now. When I look at the available evidence, though, I see substantial signs that the neutral rate has increased in recent years, and some hints that it could be very close to where the fed funds rate is now…ces. I anticipate the FOMC will most likely need more rate cuts to finish the journey. But it’s difficult to be sure how many cuts may be needed and how soon they may need to happen.” – Navigating in shallow waters: Monetary policy strategy in a better-balanced economy, Dallas Fed President Lorie K. Logan, November 13, 2024

“Shifting from my baseline to alternative scenarios, recent information suggests to me that the risk of inflation ceasing to converge toward 2%, or moving higher, has risen, while the risk of an unwelcome deterioration in the labor market has remained unchanged or possibly fallen.” – Musalem: Remarks on Monetary Policy and the U.S. Economic Outlook, St. Louis Fed President Alberto Musalem, November 13, 2024

“While now is the time to begin dialing back the restrictiveness of monetary policy, it remains to be seen how much further interest rates will decline or where they might eventually settle.” – Longer-term Considerations for Growth and Monetary Policy, Federal Reserve Bank of Kansas City President and Chief Executive Officer Jeff Schmid, November 13, 2024

All three speeches included Fedspeak for caution on the pace of rate cuts while maintaining the flexibility to follow the data. These speeches also came on the same day as the release of the October CPI data. This timely convergence of caution and circumspection is important because core CPI maintained the stabilization trend in place since a low in July (see the green line below). Meanwhile, core PCE, the Fed’s favorite indicator of inflation also looks like it is stabilizing. In other words, it seems the Fed is paying attention to stabilizing inflation patterns.

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, November 13, 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, November 13, 2024.

Shelter costs continue to drive the bulk of inflation. For October, shelter costs constituted 65% of the year-over-year increase in the CPI. Housing costs are in a paradoxical juncture where monetary policy could help maintain elevated housing costs no matter where interest rates go. The National Assocation of Homebuilders (NAHB) laments that high interest rates contribute to contraints on supply thourgh an expensive and difficult financing environment for construction loans. On the other hand, looser monetary policy could reignite a housing demand that strains supply further and drives up prices. For now, a surprise rebound in mortgage rates is tamping down housing demand.

A Friendly Message from Gold?

While inflation is stabilizing, gold may have topped out.

Two months ago I interpreted the strength in gold as indicative of a skepticism about the Fed’s implied victory message on inflation. That trend persisted until last week. The resolution of the U.S. presidential election generated a fresh surge in Bitcoin (BTC/USD) and presumably drained interest in gold. The SPDR Gold Trust (GLD) gapped down and lost 3.0%. I was hopeful that the 50-day moving average (DMA) (the red line below) would hold as support. As a (perma) bull on gold, I added call options to supplement my core GLD position. Today’s 1.0% loss in GLD further confirmed a 50DMA breakdown. This bearish technical signal means that I am unlikely to try new short-term trades for a while.

Source for charts: TradingView.com

The new inverse correlation between gold and Bitcoin indicates a sharp shift in preferences with Bitcoin getting an added advantage from expectations of a pro-crypto regulatory regime starting next year.

The Bond Market Remains Wary

Two months ago I claimed that the bond market acted wary about the Fed’s presumed victory over inflation. Sure enough, long-term yields have steadily risen ever since. The iShares 20+ Year Treasury Bond ETF (TLT), which goes up when long-term interest rates go down, is now trading near the bottom of a presumed horizontal trading range. My strategy to fade TLT has worked all the way down.

After TLT gapped up for some reason on the CPI news, I thought I missed my latest profit opportunity. So when TLT faded back to the previous day’s close, I counted myself fortunate and took profits on my latest round of TLT put options. TLT then went on to lose 1.0% for the day.

The U.S. dollar soars

The U.S. dollar index (DXY) has benefited from one tailwind after another. Now, the presumed tailwind comes from the boost it should get with increased tariffs that also promise to prop up inflationary pressures in the economy. Fewer dollars going overseas to buy goods tips the supply/demand balance in favor of a stronger dollar. Two months ago I decided to bet on continues strength in the British pound versus the U.S. dollar by buying shares of Invesco CurrencyShares® British Pound Sterling Trust (FXB). I took the opportunity to buy when FXB tested its uptrending 50DMA. The currency ETF has continued downward from there with little sign of an imminent rebound.

Conclusion

With the Presidential election behind us, the bets on stabilizing (or even stronger) inflation are clarified for now: long Bitcoin, long gold only after Bitcoin enthusiasm wanes somehow, long U.S. dollar, and short TLT. While I sold all my Bitcoin earlier in the day, I will continue to trade by buying dips. I am conflicted on the U.S. dollar as I stubbornly hold some dollar shorts while trading in and out of dollar longs. At some point, I will commit to a dollar long by shorting EUR/USD. Europe stands to lose in the next administration with a weaker NATO, more contentious relationships, and higher tariffs in a weakening economic backdrop.

The Federal Reserve has ahead as precarious a path as ever while it gets increasingly wary about stabilizing inflation!

Full disclosure: long GLD shares and calls, long PHYS, long FXB

The post The Federal Reserve 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.

“Inflation has remained stubbornly above the 2% target. Despite subdued pay growth, weak productivity has meant no corresponding fall in domestic cost pressures. And increases in university tuition fees and domestic energy bills, largely resulting from administrative decisions rather than market forces, have added to inflation more recently. CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years, in part reflecting a persistent inflationary impact both from administered and regulated prices and the recent decline in sterling. But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade.”

I took particular interest in the claim that external price pressures will fade. To do so, the global economy would have to remain weak. If so, then it is unlikely that growth in the UK will fare much better, even at the projected “slow but sustained” pace. The other possibility is that the British pound or sterling – CurrencyShares British Pound Sterling Trust (FXB) – appreciates enough that external prices go back down. If so, then Mervyn King’s hopes of rebalancing the economy with a reduction in demand for imports and an increase in exports surely will not be realized.

Adding to this conundrum for the UK economy is the stubborn persistence of weak economic growth (mainly flat) along with strong employment growth. The UK economy is getting less and less productive and thus less and less capable of offsetting inflationary pressures. This is a dynamic that I will be watching ever more closely given the BoE projects a two-year horizon over which the economy will continue to suffer high inflation and weak economic growth (aka stagflation). The implication for the currency is mixed, and I continue to expect “more of the same” for the pound.

The post The UK’s CPI inflation to remain stubbornly high for the next two years appeared first on Inflation Watch.