Punch-Bowl Powell & Rational Exuberance – March 22, 2024

Punch-Bowl Powell & Rational Exuberance – March 22, 2024
Morgan Lewis Posted on March 23, 2024

Punch-Bowl Powell & Rational Exuberance

This week, stocks posted their best week of the year after Fed Chair Powell and the Federal Reserve FOMC meeting spurred hopes that a summer pivot toward looser policy is on track. As a Bloomberg headline put it, “Fed Seen Sticking With Three 2024 Cuts Despite Higher Inflation.”

Heading into the meeting, market participants were cautious. In fact, according to BofA, citing EPFR data, US equity funds saw their biggest redemptions since 2022 in the run-up to the Fed meeting Wednesday. Market concern surrounded questions of whether recent stubbornly hot inflation data would derail a dovish Powell and kill the case for rate cuts.

Following the FOMC meeting and Powell’s presser, market sentiment shifted dramatically from one of concern to elation. Dovish Powell was back. In short, markets surged following a major collective sigh of relief after Powell seemingly made clear that rate cuts and an end of quantitative tightening (QT) are coming—data be damned.

Since November of 2023, the dominant messaging from the Federal Reserve seems to have turned decisively from “higher rates for longer” to now “higher inflation for longer” in an about-face only Wall Street could love.

With another booming week in the books for stocks, however, investor sentiment extremes continue to proliferate. Caution is warranted. According to Sentimenttrader, small traders (the retail public) are now net long the market at a record extreme of $54 billion in the futures market. The retail trader’s collective bullish bet now far exceeds the former extremes that accompanied past market tops at the post-Covid peak, the peak before the Great Financial Crisis, and the highs before the bust. Retail trader euphoria is a powerful contrary indicator, and right now retail is fully lost in “irrational exuberance.” This week, Fed Chair Powell certainly fanned the flames of that exuberance. Again, caution is warranted.

Market trepidation heading into the Wednesday FOMC was well warranted. Since the de facto Powell Pivot in December signaling looser monetary policy soon to come, inflation data has been distinctly non-cooperative. Despite the Fed’s apparent December victory lap, inflation isn’t dead, and it certainly hasn’t been defeated. We’ve had two consecutive hotter-than-expected CPI prints as well as PPI prints, and the Fed’s preferred “supercore” measure is now spiking. Similarly, inflation expectations are marching higher again, and we now have dangerously loose (inflationary) financial conditions firmly in place.

Comments from last month’s S&P Global Purchasing Manager’s Index (PMI) highlight, underscore, and crystallize market concern heading into Wednesday’s FOMC and Powell presser. As S&P put it in February, “Selling price inflation rose…and remained elevated by pre-pandemic standards. This was especially so in the service sector. As such, we will be closely watching the next release of flash PMI data for the inflation trajectory, given the uncertainty this continues to pose to rate cut plans around the world.”

Understandably, the market was concerned that in deference to the data and the Fed’s oft-repeated commitment to bring inflation back down to the Committee’s 2% target “unconditionally,” Powell might blow the whistle and call a “false start” on his own previous pivot towards the path of monetary easing.

As it turned out, however, other than reaccelerating inflation, the market had nothing to worry about. Despite the recent hotter inflation data, on Wednesday Chair Powell seemed as unconditionally committed as ever to upcoming rate cuts and an end to quantitative tightening (QT) in 2024. The fully flipped script from Jay Powell’s Volker act to an Arthur Burns redo for punch-bowl Powell has been stunning and, in HAI‘s view, equally telling.

In short, monetary policy increasingly looks severely compromised by the extremely high levels of government debt. The era of the effective use of interest rates to curb inflation appears over.

Powell’s press conference only served to emphasize the point made by BofA chief investment strategist Michael Hartnett the previous week, “The Fed is losing credibility [because it] seems very determined to cut interest rates before it reaches its 2% inflation target.”

The Powell pickle referred to in last week’s HAI is that the Fed can’t cut rates because of inflation, while simultaneously it can’t not cut rates because of a debt spiral (turbocharged by high interest rates) now running at a pace of $1 trillion every 100 days. This week at his presser, Powell delivered the closest thing to confirmation yet that the Fed has made its choice—to cut rates despite inflation.

In addition to recent data, it’s also the inflation outlook via commodity markets that’s heating up. Cranking-up the burner further under our simmering inflationary stew, the broad commodity market has been showing a little pep in its step again over recent months. Right now, energy, metals, and agriculture are all threatening to continue higher if Powell pursues the path to monetary policy easing. At this point, any further broad-based rally in commodities would, no doubt, put something of a match to the inflation powder keg.

Nevertheless, seemingly needing to cut rates even in the face of clearly mounting inflationary data, Jay Powell, on Wednesday, could do little more to save credibility than wave his hand in a weak attempt at a Jedi mind trick. He seemed to aim at fooling us all (despite the facts) into believing—”there is no inflation to see here.”

Throughout his press conference, Powell looked about as firm on inflation as a soaking wet noodle. In HAI‘s view, Powell appeared outright dismissive in the face of evidence of a recent uptick in price pressures as well as dismissive of the very real threat of embedding higher inflation for longer into the economy.

Once released, the updated FOMC Summary of Economic Projections (SEP) revealed a glaring inconsistency. The new SEP “dot plots” indicated that FOMC members projected a higher inflation rate and stronger GDP growth assumptions, but maintained expectations for three dovish rate cuts in 2024.

CNBC’s Steve Liesman cut right to the quick with the first question of the presser. “Mr. Chairman… Rates [three rate cuts] were kept the same this year, but inflation is higher, and growth is higher. Does it mean more tolerance for higher inflation?”

Powell’s response was a far cry from his definitive 2022 Jackson Hole mic drop moment. Back then, the Chairman looked and sounded like Paul Volker in vowing to crush inflation, crush it now, and crush it “unconditionally.”

But now Powell responded to Liesman saying: “Well, it doesn’t, no, it doesn’t mean that. What it means is that we’ve seen…inflation data came in a little bit higher as a separate matter and I think that caused people to write up their inflation, but nonetheless, we continue to make good progress on bringing inflation down and so…we’re strongly committed to bringing inflation down to two percent over time. That is our goal, and we will achieve that goal. Markets believe we will achieve that goal, and they should believe that, because that’s what will happen over time. But we stress over time. And so, I think we’re making projections that do show that happening and we’re committed to that outcome, and we will bring it about.”

So, despite hotter inflation data and higher inflation projections from FOMC members, they are making “good progress” on bringing down inflation? Despite inflation that’s already well above target and heating up, the Fed believes they are making such “good progress” that they’re still guiding towards three dovish (inflationary) rate cuts this year? That doesn’t add up.

Nevertheless, according to Powell there is no implicit suggestion that the Fed is indeed willing to tolerate higher inflation for longer. Apparently, they can both ease policy and bring inflation down to 2% over time, but “we stress over time.

As this author was watching the presser, the thought occurred that the only thing missing was a sleazy wink and a “trust me.”

WSJ reporter Nick Timiraos asked another interesting question. Essentially, Timiraos asked if the hotter inflation data so far this year has alerted the FOMC to any change in the trend toward a lower rate of inflation seen over the second half of last year.

Powell’s response: “I want to start by saying, I always try to be careful about dismissing data that we don’t like. So, you need to check yourself on that, and I’ll do that, but so I would say the January number, which was very high, the January CPI and PCE numbers were quite high, there’s reason to think that there could be seasonal effects there. But nonetheless, we don’t want to be completely dismissive of it. The February number was high, higher than expectations, but we have it at currently well below 30 basis points core PCE, which is not terribly high. So, it’s not like the January number. But I take the two of them together and I think they haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes-bumpy road toward two percent. I don’t think that story has changed.”

So, in other words, Powell doesn’t want to be “completely dismissive.” He’ll settle for just mostly dismissive. Despite “data that we don’t like,” nothing has “really changed the overall story.” We can cut rates three times this year and, despite the hotter data, inflation will still be on a bumpy road to the 2% target over time, and let’s stress, over time. Wink, wink—trust me. Yikes! Again, that just doesn’t add up.

The central bank has a price stability mandate, and rather than 2%, the Fed let inflation reach the 9.1% stratosphere as recently as June of 2022, and now the Fed Chair is again comfortable being mostly dismissive of recent higher inflation data just as he’s guiding toward stimulative (inflationary) rate cuts? Double yikes! 

HAI‘s take: Powell seems awfully intent on setting the table for rate cuts, and seems mighty willing to paint the narrative rose colored if it best supports the outcome he’s already itching for. The evidence is mounting, whether Powell wants to cut rates or not, he seems to need to cut rates.

Now, to really hammer home Powell’s inconsistency with regard to the inflationary reality, let’s return to S&P Global’s previous February comment that they “will be closely watching the next release of flash PMI data for the inflation trajectory, given the uncertainty this continues to pose to rate cut plans around the world.”

Well, according to that latest S&P Global flash PMI out this week, “inflationary pressures showed signs of picking up. Input costs rose at the fastest pace in six months, while firms increased their selling prices to the largest extent since April last year.”

S&P Global continued, “rates of output price inflation accelerated sharply across both manufacturing and services, quickening to 13- and eight-month highs as companies passed through higher input costs to their customers.”

In the words of Chris Williamson, Chief Business Economist at S&P Global, “A steepening rise in costs…meant inflationary pressures gathered pace again in March… The steep jump in prices…hints at unwelcome upward pressure on consumer prices in the coming months.”

I don’t know about you, dear reader, but that doesn’t sound like “mission accomplished” on the inflation fight to me. It sounds like: Houston, we have a problem. Nevertheless, according to Powell, “it will likely be appropriate to begin dialing back policy restraint at some point this year…[and] the general sense of the Committee is that it will be appropriate to slow the pace of [balance sheet] runoff fairly soon.”

Wednesday wasn’t a good day for the American consumer struggling to keep up with inflation, and it wasn’t a good look for Jay Powell or Federal Reserve credibility. Nor was it a good look for the Fed when gold broke out to new all-time highs immediately following Wednesday’s central bank shenanigans.

Now, gold subsequently corrected on Thursday and Friday, but gold was extremely overbought technically after its latest spike. Furthermore, futures market speculative long positioning as revealed in recent Commitment of Traders reports had gotten excessively frothy. As a result, gold’s late week correction isn’t particularly surprising.

That said, right now, it’s important to focus on the major underlying trend propelling gold, not the short-term trade. That underlying propellant is debt spiral dynamics and the associated breakdown of the post-Bretton Woods era of effective modern monetary policy. Gold may be a little ahead of itself in the near-term, but with the Fed looking increasingly like it is forced to ease policy despite high inflation, gold’s ultimate path to a significantly higher destination is hardly in doubt.

With wartime-like deficit spending at a run rate of $1 trillion every 100 days, ballooning government interest payments, an inflation problem, and the increasingly obvious breakdown of effective inflation-fighting monetary policy, HAI trusts that the financial insurance bid for gold is just getting started. By extension, HAI believes gold’s breakout, while certain to be volatile, is merely in its infancy.

While financial assets surge and celebrate the return of punch-bowl Powell with “irrational exuberance,” HAI believes gold investors can enjoy rational exuberance from the knowledge that, unlike financial assets, gold’s ultimate ascent is built upon the strongest of foundations and fueled by $1 trillion reasons every 100 days.

To date, gold’s breakout is a slow grind higher amid a hard-fought battle. The move higher is a process, and we may yet have to face further corrections and tiresome tests of the breakout zone. But at this point, the inflation fight looks to be up against the ropes, bloodied, bruised, and battered, while punch-bowl Powell bears no resemblance whatsoever to Paul Volker.

Eventually, HAI expects gold to break all restraining tethers and enter a strong, full-bull trending-momentum phase. That’s when the fireworks begin and the fun starts for gold holders and mining stock owners, because when the precious metals sector bulls, it bulls hard.

So, for now, gold continues to fight the battle of the breakout, but the monetary maestros look increasingly likely to deliver rate cuts into elevated inflation later this year. If so, the fireworks-and-fun phase for gold may not be a long wait.

Weekly performance: The S&P 500 surged 2.29%. Gold was off 0.07%, silver was lost 2.13%, platinum was hit by 4.78%, and palladium was crushed by 8.44%. The HUI gold miners index lost 0.92%. The IFRA iShares US Infrastructure ETF gained 2.41%. Energy commodities were volatile on the week. WTI crude oil ended nearly flat, up 0.06%, while natural gas surged 9.82%. The CRB Commodity Index was up 0.40%. Copper was down 2.84%. The Dow Jones US Specialty Real Estate Investment Trust Index was off 0.94%. The Vanguard Utilities ETF was up 1.55%. The dollar index was up 1.09% to close the week at 104.18. The yield on the 10-yr U.S. Treasury lost 9 bps to close at 4.22%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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