No Wonder Gold is Flying
This week, after nearly succumbing to a vision of economic gloom, equity traders convinced themselves that growth and higher stock prices are sustainable as a widely expected dovish shift in the monetary regime nears. This week, in the short span of 48 hours, Wall Street Journal chief economics correspondent Nick Timiraos (believed to be the unofficial mouthpiece for Fed messaging to markets) was almost single-handedly the cause for excessive market volatility and wild fluctuations in rate cut bets on next week’s Fed FOMC policy meeting.
The question isn’t whether the Fed will cut rates. It will. At least one 25 basis-point cut is in the bag. The question spinning the collective mind of the market is: by how much will the Fed cut? Will it be a cautious 25 or a more aggressive 50 basis-point cut? In guiding the market toward an answer to that question, Timiraos seemed to imply the affirmative to both outcomes, at the same time.
By the end of the week, increased bets by market participants for an outsized 50 basis point rate cut next week sent almost everything, aside from the dollar and Treasury yields, significantly higher. The increased chances of a 50-point cut, however, were somewhat counterintuitive. Given that the latest Consumer Price Index (CPI) and Producer Price Index (PPI) data for August came in a bit hotter than expected, expectations would normally favor a smaller cut—or even no cuts at all. That said, we’re not in Kansas anymore. Far from normal, these are exceptional times.
Headline CPI was as expected—0.2% month over month (M/M) and 2.5% year over year (Y/Y), down from 2.9% previously. However, core CPI (ex-food and energy) was a tick higher than expected at 0.3% M/M vs. the 0.2% expected. Year over year, core CPI remained stubbornly elevated at the same 3.2% as the previous month. Moreover—and troublingly—heavily weighted shelter inflation started to move higher again after a long but shallow decline.
The CPI data was initially met with a bearish market response after Timiraos seemed to crush market dreams for a 50 basis-point cut by saying, “A bigger increase in cyclically-sensitive shelter prices in August will make it harder for Fed officials to shake reservations about starting rate cuts with a 50 bps reduction next week.” The market interpretation of Timiraos’s comment was that, given the hotter-than-expected data, Powell and the Fed wanted to prepare markets for a smaller 25 basis-point move.
Michael Every, global strategist at Rabobank, agreed. Every acknowledged that in light of the data, the Fed will likely cut rates by only 25 basis points next week. He suggested that it is cutting at all only “because of ‘stag-like’ weak payrolls, not low ‘flation.’” The always colorful strategist continued, “The latest CPI report not only makes that clear, but highlights the potential risks of the Fed getting this all wrong and looking like clowns in 2025.”
But that was Tuesday. By Wednesday, Timiraos seemed to point in the other direction. In the WSJ, the “fedwhisperer” cited Jon Faust, former senior advisor to Fed Chair Powell, as saying, “my preference would be slightly toward starting with 50. And I still think there’s a reasonable chance that the FOMC might get there as well.” This time, the market interpretation was that Timiraos was signaling that a larger 50 basis-point jumbo cut was, in fact, in the cards. Asset prices surged.
Later in the week there was ex-New York Fed-head Bill Dudley, who furthered Wall Street salivation over a jumbo cut when he said, “I think there’s a strong case for 50, I know what I’d be pushing for.”
Then on Thursday, Timiraos again fanned the 50 basis-point flames by quoting former Fed vice chair Donald Kohn. Kohn said, “we have supported this [economic] growth by doing less and less saving, and more and more borrowing. That’s not sustainable… I think the risk management has shifted to the labor market and favors doing 50.” Predictably, risk assets jumped again. All told, according to CME FedWatch, despite disappointing inflation data, market odds for a 50 basis-point Fed jumbo cut increased on the week from a low of 18% up to 49% on Friday.
In his comments, however, Kohn validated the policy critique of HAI favorite economist Lacy Hunt. As Dr. Hunt has pointed out, the U.S. is in the unhealthy condition of net negative national savings (NNNS) for just the third time (the Great Depression, the Great Recession, and now) in the last 100 years. But rather than focus on incentives for saving, Kohn, like most of his colleagues, merely advocates a greater reduction in the cost of (and greater enabling of) that unsustainable borrowing.
And the unsustainable borrowing isn’t just a consumer phenomenon. This week the Congressional Budget Office (CBO) announced that in August the federal government took in $307 billion of revenues against $688 billion of outlays for a one-month deficit of $381 billion—a $90 billion deeper deficit than expected.
Additionally, according to the Committee for a Responsible Federal Budget (CRFB), from September 2023 through August 2024, the federal budget deficit totaled $2.1 trillion based on estimates from the CBO, a nearly $500 billion increase from the CRFB’s previous analysis last month in which the 12-month rolling deficit was $1.6 trillion.
As recent McAlvany Weekly Commentary guest Stephanie Pomboy said this week, “holy budget deficit, Batman!… No wonder gold is flying.”
Unsustainability is everywhere, and, in HAI’s view, it’s becoming the real, if unofficial, driver of Fed plans to cut rates and lower the cost of borrowing. The US is now drowning in over a trillion dollars of interest expenses over just the last 11 months. Worse yet, consider that in the next three years, the US Treasury must refinance $15.5 trillion of debt with a weighted average coupon of 2.3% versus the current yield of 5.3% for Treasury bills.
In other words, unless the Fed wants to rapidly accelerate a sovereign debt crisis, it must cut rates aggressively to help the U.S. government refinance that $15.5 trillion mountain of debt coming due at rates low enough to slow debt-spiral dynamics. The implication is clear. In HAI’s view, whether the Fed cuts 25 or 50 basis-points next week, and regardless of inflation, the labor market, or Nick Timiraos’s latest whisperings, the likely path for the Fed funds rate is lower, and probably ultimately lower than most expect.
In addition to a world scrambling to de-dollarize reserves, gold is now benefiting from the confluence of two additional factors; a government that’s crossed the Rubicon on debt, and a trapped Fed with a seemingly new 3rd mandate to cut rates to extend the timeline on a US government debt spiral. Indeed, as Steph Pomboy said, “no wonder gold is flying.”
Weekly performance: The S&P 500 was up 4.02%. Gold was up 3.41%. Silver jumped 10.26%. Platinum added 9.59%, and palladium surged 19.20%. The HUI gold miners index gained 11.99%. The IFRA iShares US Infrastructure ETF was up 4.06%. Energy commodities were volatile and higher on the week. WTI crude oil was up 1.45%. Natural gas was up 1.32%. The CRB Commodity Index was up 2.62%. Copper gained 3.99%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 3.99%. The Vanguard Utilities ETF was up 3.32%. The dollar index was down 0.35% to close the week at 100.79. The yield on the 10-yr U.S. Treasury was down 6 bps to close at 3.66%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
