Good for Gold
This was another interesting week in the wild world of Wall Street. The big market-moving news surrounded Wednesday’s release of Consumer Price Index (CPI) data. Over the last months, “the Street” has turned increasingly cautious over the outlook for more Federal Reserve rate cuts as progress on the inflation fight has stalled and the Fed has adopted a significantly more hawkish tone. The increased hawkishness has been in response to headline CPI (along with other inflation indicators) that has been trending higher and moving away from the Fed’s 2% target for a while now. Headline CPI has moved from 2.4% year-over-year (y/y) in September to 2.6% y/y in October, to 2.7% y/y in November. Meanwhile, over the same period, core CPI (ex-food & energy) has remained stuck at 3.3%.
This week’s December CPI report was eagerly awaited by the market, as any signs of progress on cooling prices would increase the odds that the Fed would give Wall Street more of the 2025 rate cuts it craves. On Wednesday, the December CPI report showed headline CPI up 0.4% month-over-month (m/m) vs. 0.3% expected, and up 2.9% y/y in-line with expectations. The results continued the uptrend in headline CPI, and the m/m reading was the highest since March, while y/y was the strongest since July. So ultimately, the headline CPI reading offered nothing for rate-cut cheerleaders to celebrate.
Core CPI, however, did deliver some fodder to bolster hopes of a more dovish Fed policy trajectory. CPI excluding food and energy increased by 0.2% m/m vs. 0.3% expected, and the annual rate was 3.2%, a notch down from the month before and slightly better than the 3.3% forecast.
Despite that fact, market expectations continue to forecast no rate cut at the Fed’s late January policy meeting. However, financial markets increased their bets on rate reductions through June. The better-than-expected core CPI and the resulting uptick in hopes for more cuts past January were all the excuse the market needed to party hard, and the major indexes launched higher.
Now, while markets celebrated the easing in core CPI this week, HAI doesn’t expect optimism on inflation to last.
Why? Well, recall from last week’s HAI that the latest ISM Services PMI “prices paid” component has increased from as low as 56 last summer to a piping hot 22-month high at a 64.4 reading two weeks ago. That’s important when considering that this week Apollo Global said that, according to their research, ISM Services prices paid is a strong leading indicator of Core CPI six months forward.
In other words, current Core CPI readings reflect the much lower ISM Services prices paid readings of six months ago, while over the next six months Core CPI will likely mimic the sharp increase we’ve seen since in ISM Services prices paid and begin to trend meaningfully higher again.
In addition, we already know that last Friday the University of Michigan’s 5-year/10-year inflation expectations measure spiked up to 3.3%—the highest level since 2008—from 3%. Now oil is the great inflation force multiplier, and inflation expectations are highly correlated with oil and gas prices. Interestingly, we’ve seen the recent spike in UMich inflation expectations occur with oil prices below $80 per barrel—a far cry from the levels over $120 per barrel seen in 2022. But now, with Core CPI already looking set to move higher and UMich inflation expectations already at 17-year highs, oil prices may now be ready to rally again. That’s because last week the U.S. imposed stiff sanctions on Russian oil and gas. Those sanctions will likely add a new potent ingredient to the inflationary stew already cooking.
On Friday, January 10th, amid a policy-making last hurrah, the Biden administration, in coordination with the UK, hit the Russian oil industry with a heavy barrage of significant sanctions. Biden’s sanctions targeted two firms that handle more than a quarter of Russia’s seaborne oil exports, as well as vital insurers, traders linked to hundreds of cargoes, and oil tankers.
According to the Financial Times, “The Biden administration on Friday issued sweeping sanctions targeting the Russian energy sector, taking aim at Moscow’s oil revenues just days before Donald Trump takes office. The measures include sanctions on Russian oil producers Gazprom Neft and Surgutneftegas, and the blacklisting of 183 vessels involved in Russian energy exports. Dozens of traders, Russia-based oilfield service providers, and energy officials were also targeted.”
In a statement, Treasury Secretary Janet Yellen said the moves are aimed at “ratcheting up the sanctions risk associated with Russia’s oil trade, including shipping and financial facilitation in support of Russia’s oil exports.”
Interestingly, with just nine days left in its term, the Biden administration finally levied the sanctions on Russian oil and gas that it was seemingly too afraid to issue earlier—likely because of the risk that such a move might have triggered higher inflation and severe U.S. bond market, stock market, and global economic dislocations.
Following the new sanctions announcement, oil prices spiked to a three-month high. Why? Because Russian oil exports are about 4.8 million barrels per day, or equal to roughly 11% of global oil exports, and global oil exports have not risen on net since 2005. In other words, Russian supply is a crucial component of global supply. Oil and gas prices will likely be on the rise if Russian product is subtracted from the global balance of energy supply. Again, oil is the great inflation force multiplier. Any increase in oil, and by extension gas prices, will likely kick what already looks to be re-accelerating inflation into an even higher gear.
Furthermore, the sanctions may not be easy to undo. As Bloomberg noted, “Should he [Trump] try to undo the moves, Trump could face pressure from Congress, where Republican members had urged President Joe Biden to do more to crack down on Russian energy revenues.”
In short, the U.S. still has an inflation problem. In HAI’s view, it’s likely to get worse soon. Unfortunately, the U.S. also has a debt problem, and that’s getting worse as well. Just this week, with updated numbers for December in hand, we now know that U.S. “true interest expense” (net interest expenses + entitlement spending) is running at 111% of tax receipts in fiscal 2025 year-to-date (October to the present).
In other words, the U.S. is far from able to pay its interest and interest-like obligations out of tax receipts. In fact, trailing 12-month U.S. Federal outlays are now just shy of $7 trillion, a level the U.S. has never before hit outside of four months of Covid-crisis fiscal insanity from February 2021 through May 2021.
Importantly, this time we are again flirting with Covid-level spending, completely without the perhaps justifying crisis. Furthermore, given the U.S. interest refinancing coming due in the first half of 2025, it seems inevitable that U.S. government outlays are once again about to top $7 trillion. Adding to the fiscal gloom, the latest data also confirms that despite a booming stock market bubble and near full employment, tax receipts have surprisingly turned negative year-over-year.
This combination of both an inflation and debt problem brings us back to the Fed and Powell’s pretty pickle. The Fed is trapped. It can hold rates high or even raise rates to fight inflation, but only at the cost of triggering an interest expense-fueled debt spiral. Or the Fed can cut interest rates on the short end of the curve and issue a bunch of T-bills to finance the government at a lower interest expense—but only at the cost of likely supercharging inflation. Consequently, it now appears that the Fed is firmly in “the lesser of two evils” territory.
Of crucial importance for asset allocators, however, is that regardless of which “wrong way” policymakers choose to go, gold wins. The U.S. is now heading toward an emerging market-like inflationary debt crisis where the choices are print-and-inflate or default. In HAI’s view, both are good for gold.
On the cusp of the swearing in of the second Trump administration, however, one thing is clear. DOGE alone is no answer to the U.S. debt spiral dynamics. As last week’s HAI pointed out, outside of entitlements (which will not be cut), defense spending (which is actually increasing), and interest expense (which the Fed can slash only if its willing to take the inflationary consequences), there is not enough budget left for DOGE to cut to right the fiscal ship.
In HAI’s view, the incoming administration understands the predicaments we now face after decades of unsustainable policy. Many in the incoming administration are also uniquely qualified to attempt a fix and appear motivated to do so. Ultimately, the optimism is real. But HAI cautions that even in the best of circumstances, the road from here to reinvigorated national health will be neither smooth nor easy. Again, the reality is that the U.S. is facing an emerging market-like inflationary debt crisis where the choices are merely variations of print-and-inflate or deflationary default. As such, its likely that, one way or another, things get worse before they get better. So, as we navigate the rocky road ahead, from an asset allocation standpoint, HAI reminds readers that both paths are good for gold.
Weekly performance: The S&P 500 was up 2.91%. Gold was up 1.24%, silver was down 0.55%, platinum was off 3.07%, and palladium was nearly flat, down 0.13%. The HUI gold miners index gained 1.06%. The IFRA iShares US Infrastructure ETF surged 6.88%. Energy commodities were volatile and mixed on the week. WTI crude oil was up 1.07%, while natural gas was down 1.03%. The CRB Commodity Index was up 1.67%. Copper was up 1.50%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 4.89%. The Vanguard Utilities ETF was up 4.42%. The dollar index was off 0.26%, to close the week at 109.20. The yield on the 10-yr U.S. Treasury was off 14 bps to close at 4.63%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
