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.

Nevermind that a read hotter than consensus has little impact on the current trend. The chart below from the U.S. Bureau of Labor Statistics shows that even as core CPI (all items less food and energy) is flattening out a bit (the red line), the “sticky” shelter component of inflation is still hurtling downward (the purple line).

With the trend still favoring the death of inflation, I think of “sticky” as a reference to people’s impatience with an inflation component taking too long to converge with the overall average inflation level. The CPI report highlighted the relative stubbornness of shelter inflation:

“The shelter index increased 0.6 percent in January, and was the largest factor in the monthly increase in the index for all items less food and energy. The index for owners’ equivalent rent rose 0.6 percent over the month, while the index for rent increased 0.4 percent. The lodging away from home index increased 1.8 percent in January…The shelter index increased 6.0 percent over the last year, accounting for over two thirds of the total 12-month increase in the all items less food and energy index.”

The bubble chart below from the U.S. Bureau of Labor Statistics shows the outsized influence of services less energy services on total inflation (the large purple bubble). This major component includes shelter. Its relative importance of 60.9 dwarfs the relative importance of all other major components of inflation.

Given the angst directed at the shelter component of inflation, I looked at what the National Association of Home Builders (NAHB) had to say about this CPI report. The industry group provided a reassuring conclusion: “the NAHB forecast expects to see shelter costs decline further in the coming months.  This is supported by real-time data from private data providers that indicate a cooling in rent growth.” So while the housing price picture is mixed with existing homes on the uptick and new homes on the downtick, overall rents should continue a cooling pace as expected.

Unfortunately for those traders and investors buying stocks and bonds in anticipation of rate cuts, this reminder of inflation’s stickiness pushed out expectations for the first rate cut from the Federal Reserve. Over-eager financial markets pushed out the first rate cut from May to June. This is a bitter pill to swallow for those who started buying stocks and bonds late last year in anticipation of a rate cut in March (because the Fed admitted to inflation’s death of course). The chart from the CME FedWatch Tool shows how the odds favoring a May rate cut immediately evaporated.

The Fizzle and Sizzle in Financial Markets

Interestingly, currency markets and the bond market have been moving counter to the rallies in the S&P 500 (SPY) and the NASDAQ (COMPX). The 2024 rally in the U.S. dollar index (DXY) has taken the index ABOVE the point where currency traders dumped the dollar in the wake of inflation’s death. The chart below from Tradingview.com shows a bullish breakout for the dollar last month above its 50-day moving average (DMA) (the red line) and a successful test of the trend line as support earlier this month.

The dollar’s rally complicates my bullish trades on the Canadian dollar but also provides my latest opportunity to fade USD/CAD (Invesco CurrencyShares Canadian Dollar Trust (FXC)) within the trading range. I am net long the U.S. dollar by being short EUR/USD (Invesco CurrencyShares Euro Currency Trust (FXE)).

Excluding a sharp countertrend rally at the end of January, iShares 20+ Year Treasury Bond ETF (TLT) has sold off most of 2024.

These trends further reinforce the notion and fear that perhaps earlier rate cut expectations were indeed premature. After the market’s pullback (the S&P 500 lost 1.4% and remains in an uptrend) will stocks also concede the point or will they return to ignoring deteriorating market breadth and other signs of caution in the stock market?

The volatility index (VIX) may have already blown off enough steam to soothe the groans of the bulls…for now. Note carefully how the VIX stopped going down this year and thus has an ever so slight uptrend going…

Be careful out there!

Full disclosure: net long U.S. dollar

The post From Inflation Fizzle to Sizzle appeared first on Inflation Watch.

This admonition is unsurprising given Macklem’s general reluctance to declare victory over inflation. While the Bank of Canada increasingly sees the elements needed to get inflation back down to 2%, Macklem stated that “we are not there yet.” They need to see sustained and further (for “a number of months”) downward momentum in core inflation.

Cautious About the Signs of Victory Over Inflation

December’s statement on monetary policy also reflected the Bank of Canada’s wavering. The statement estimated that “data and indicators for the fourth quarter suggest the economy is no longer in excess demand. The slowdown in the economy is reducing inflationary pressures in a broadening range of goods and services prices.” These conditions should have generated a declarative victory statement. Instead, the Bank of Canada proceeded to posture staunchly against inflation: “Governing Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed. Governing Council wants to see further and sustained easing in core inflation, and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

Still, in the interview, Macklem acknowledged that rates are likely to start coming down in 2024. He just refused to provide a timetable.

The Soft Landing

The interviewer pointed out that the scenario Macklem portrays sounds like a “soft landing” for the economy. Macklem was careful not to use that term. Instead he pointed out that much of the adjustment in the labor market has come through a reduction in vacancies instead of a large rise in unemployment. An anticipated weakness in growth for the next 2 to 3 quarters should not generate a “deep” recession. Macklem directly claimed that “we can get inflation back to 2% without a recession.”

This year will be a transition year. By the end of the year, the economy should be in soft landing mode if all goes well.

The Canadian Dollar

The Bank of Canada released its December statement on monetary policy just as the U.S. dollar was experiencing a slight relief rally against the Canadian dollar (USD/CAD) (or the Invesco CurrencyShares Canadian Dollar Trust (FXC)). The slide resumed with the Federal Reserve’s decision on monetary policy the following week and the resulting celebration over the implicit announcement that inflation in the U.S. is dead. I had long anticipated the decline at the time with a target of testing the lower part of a trading range in place since September, 2022.

After taking profits, I am back to accumulating a short position. I expect the Bank of Canada’s on-going caution and the Bank’s refusal to get dovish to act as a tailwind for the Canadian dollar. The chart below from TradingView.com shows volatility in USD/CAD distinctly driven by key events. The Bank of Canada’s next Monetary Policy Report will come on January 24th. The Fed comes around the week after.

So, overall, I continue to favor playing the trading range in USD/CAD as an eventual trip to or toward the bottom of the range. I currently cannot foresee catalysts that will push the currency pair to stray too far away from the range. If USD/CAD escapes the range, I think the odds favor a breakdown over a breakout.

Be careful out there!

Full disclosure: short USD/CAD

The post Bank of Canada’s Macklem: The End is In Sight But Rates Are Not Returning to Pre-Pandemic Levels appeared first on Inflation Watch.

The Bank of Canada is worried about higher energy prices, “structural pressures” in the housing market primarily related to supply shortages (which it acknowledged must first be addressed on the supply side), and “persistence in underlying inflation.” This underlying inflation consists of elevated “near-term inflation expectations and wage growth” and corporate pricing decisions that are “normalizing only slowly.” Core inflation on a year-over-year basis has come down, but the 3-month view shows little downward momentum. Accordingly, the Bank of Canada put the country on notice that it is leaving the door open to future rate hikes because of the stubborn uncertainty in getting inflationary pressures down.

Yet, the BoC did not proceed with a rate hike. Counterbalances to the increased inflation risks remain. Overall supply and demand in the Canadian economy is almost in balance with the trend favoring excess supply. The BoC also downgraded its outlook for economic growth because the economy slowed more than expected back in July; less excess demand exists than expected.

So while the BoC hiked its expectation for inflation from 3% to 3.5% for next year, the central bank is sticking to its longer-run projection of 2% in 2025. Thus, Macklem felt confident in reassuring Canadians: “with clearer evidence that monetary policy is working, Governing Council’s collective judgment was that we could be patient and hold the policy rate at 5%.“ Interest rates will stay higher for longer and the inflation target remains in sight.

Corporate and Government Behavior Working Against Monetary Policy

Companies and Canadian governments in aggregate are not cooperating with the objectives of monetary policy.

Canadian companies are still passing along price increases to consumers faster than normal. From the Monetary Policy Report:

“Corporate pricing behaviour has yet to normalize. Businesses continue to increase prices more frequently and by a larger amount than normal… This may indicate that households and businesses are, respectively, expecting to pay more and charge more for goods and services. High inflation expectations could also feed into wages.”

I assume this dynamic also comes from lingering excess demand which makes consumers less price sensitive. The coming era of excess supply should work counter to this effect.

During the Q&A Macklem pointed out that the fiscal spending plans are working against monetary policy. Aggregate government plans will grow spending by 500 basis points greater than the potential growth of the Canadian economy. Thus, the economy will add more demand than supply. In the past year, growth in government spending was below 2%. Macklem indicated that it would be helpful if fiscal and monetary policy were “rowing together.” The BoC’s forecasts take into account the potential future inflationary pressure from government spending.

The Canadian Dollar Trade

The bump higher in hawkish rhetoric did not benefit the Canadian dollar, perhaps because the BoC maintained its longer-term expectation for inflation. Weakness in the currency Invesco CurrencyShares Canadian Dollar Trust (FXC) or strength in USD/CAD continued until the Federal Reserve’s last policy announcement. Financial markets painted a dovish interpretation to the accompanying news even though it read like nothing materially changed.

I did not expect the drift higher (with high volatility) in USD/CAD as I accumulated a short position. I continue to hold the position as I see two main factors working against my thesis reaching their own individual extremes.

The biggest shift against my original setup was a big increase in the spread on 10-year yields between U.S. and Canadian bonds. Just over a month ago this spread sat at a level that looked like a potential bottom. Shortly thereafter, the bottom dropped out. The spread was last this wide back in March, 2019. This large spread serves advantage to the U.S. dollar over the Canadian dollar. From World Government Bonds:

Oil has also worked against my original thesis. Oil did not stabilize. While it soon spiked higher in response to Hamas’s attack on Israel, selling in oil resumed in about 10 days. Last week, the United States Oil Fund, LP (USO) hit a 3+ month low. While this decline should reduce the Bank of Canada’s fear that higher energy prices will bleed their way into pressures on core inflation, it also works against the Canadian dollar as a commodity currency. I have dropped any expectation on oil although I am net short USO. From TradingView.com:

From a technical perspective, USD/CAD remains well-supported by its uptrending 50-day moving average (DMA) (the red line below). I still expect this uptrend to break to the downside as the extremes working against the Canadian dollar lose steam. To the upside on USD/CAD I have a clear stop loss point above the peak created by the reaction to the Federal Reserve’s November 1st announcement on monetary policy. From TradingView.com:

Be careful out there!

Full disclosure: short USD/CAD, net short USO (short shares, long call spread)

The post Canada’s Version of Higher for Longer: Inflation Risks Have Increased appeared first on Inflation Watch.

Back in April, the Bank of Canada (BoC) described a goldilocks narrative on inflation. This narrative featured the annual change in the Consumer Price Index inflation (CPI) gradually returning to the 2% target at the end of 2024 with economic growth picking up alongside inflation’s downward glide path in 2024. Just two months later in June, the Bank of Canada raised concerns about stubborn inflation and on-going high excessive demand. Accordingly, the BoC took its finger off the pause button on rate hikes and wrote an insurance policy on inflation with one more rate hike. The latest stall in inflation’s trend caused market expectations of a rate hike in October to surge from 23% to 42%.

The Canadian dollar surged along with rate hike expectations. The Canadian dollar was already rallying against the U.S. dollar (USD/CAD) going into the inflation print despite the U.S. dollar’s strength against other major currencies. The chart below shows how the Invesco CurrencyShares Canadian Dollar Trust (FXC) gapped higher at the open but faded from the intraday high. While the intraday action may represent an element of sell on the news, I think the path of least resistance is higher for the Canadian dollar until some new inflation data contradicts the revival of inflation concerns. I sold a small position short on USD/CAD to take advantage of the small fade.

I am not expecting the Federal Reserve’s coming announcement on monetary policy to change the trajectory. Accordingly, I will add to my position if USD/CAD rebounds further.

Drivers of Core Inflation

Core inflation was supported by accelerating rent prices. Ironically, Statistics Canada partially blamed high mortgage rates which are of course higher thanks to the BoC’s rate hikes to fight inflation:

“Shelter prices were up 6.0% on a year-over-year basis in August, after increasing 5.1% in July. Faster growth in shelter prices was led by the rent index, which rose 6.5% year over year nationally, after a 5.5% gain in July. Among other factors, a higher interest rate environment, which may create barriers to homeownership, put upward pressure on the index.”

Presumably, the higher mortgage rates are forcing more people than usual to choose renting over buying and in turn pressuring vacancy rates. Lower vacancy rates tend to push rent prices higher.

I might next need to write about a Canadian inflation conundrum!

Be careful out there!

Full disclosure: short USD/CAD

The post A Stall in Canada’s Core Inflation Narrative appeared first on Inflation Watch.

“While CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation. With the large price increases of last year out of the annual data, there will be less near-term downward momentum in CPI inflation. Moreover, with three-month rates of core inflation running around 3½-4% since last September, underlying price pressures appear to be more persistent than anticipated. This is reinforced by the Bank’s business surveys, which find businesses are still increasing their prices more frequently than normal.”

I have seen more and more references to base effects regarding U.S. inflation. In the previous two years, base effects could be used to dismiss inflation’s threat. This year, base effects from more challenging comparables are looming as the end of the tailwinds for disinflation (on a year-over-year basis). The timing is poor. As the Bank of Canada noted, underlying inflation has gone nowhere for almost a year. At this point, sticky inflationary pressures cloak more uncertainty around prior inflation expectations:

“In the July MPR projection, CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in the January and April projections. Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability.”

Surprisingly, markets took the news in stride. At the same time the U.S. stock market celebrated a pleasing report on U.S. June inflation, the Bank of Canada’s rate hike did not dampen spirits about the prospects for a more dovish Federal Reserve. Currency markets reacted as though the Fed might even be closer to rate cuts as losses in the US. dollar continued apace.

In fact, the market almost seemed to skip right over the Bank of Canada’s news. While majors like the euro and the British pound rallied all day against the U.S. dollar, the Canadian dollar enjoyed just brief intraday strength in the wake of the Bank of Canada’s decision to hike rates another 25 basis points. At the time of writing, USD/CAD is only just now returning to its low point following the rate hike (and looks stalled right at support).

On a daily basis, the Canadian dollar looks set to resume its momentum against the U.S. dollar IF USD/CAD breaks below yesterday’s low. Otherwise, a countertrend rebound could take USD/CAD right back to downtrending resistance at the 50-day moving average (DMA) (the red line below) as the next move.

I remain bearish on USD/CAD (bullish the Canadian dollar), and I expect rallies to continue to fail just as they have since September. The path downward on USD/CAD (upward for Invesco CurrencyShares Canadian Dollar Trust (FXC)) has been slow and choppy yet ever so slightly biased toward more relative strength for the Canadian dollar. The next major test comes with the Federal Reserve’s meeting later this month. More Fed hawkishness at that time could refresh the U.S. dollar against all majors for a spell.

Be careful out there!

Full disclosure: no positions

The post Base Effects Add to the Bank of Canada’s Inflation Concerns appeared first on Inflation Watch.