Sive Morten
Special Consultant to the FPA
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Fundamentals
The gold market shows a bit different reaction on the recent bulk of statistics that we've got in two weeks. In general, reaction stands positive but not as strong as, say, on the FX market. This is because of the tight relation to interest rates. Despite relatively poor Retail Sales report, interest rates remain under pressure of two drivers - direct changing of the interest rates, which could start as soon as on March, and indirect rate increase that should be the by-product of the coming quantitative tightening program. These two moments do not let the interest market to "relax".
Market overview
Gold was flat on Monday, hovering near a three-week low, as traders awaited December U.S. inflation data that could reinforce the case for earlier-than-expected interest rate hikes by the U.S. Federal Reserve after weaker jobs data. Fed funds futures have priced an almost 90% chance of a rate hike in March and a more than 90% chance of another one by June.
An uptick in retail appetite for physical gold prompted dealers in India to charge premiums last week, while upcoming Lunar New Year festivities brightened the outlook for sales in Singapore. U.S.-Russia talks over rising tension in Ukraine also have traders on the edge, as the two sides seem far apart and failure risks an armed confrontation on Europe's doorstep.
Goldman Sachs expects the Fed to raise interest rates four times this year and begin the process of reducing the size of its balance sheet as soon as July. The investment bank, which earlier predicted the Fed would raise rates in March, June and September, now expects another hike in December.
Gold prices rose on Tuesday, supported by a weaker U.S. dollar and Treasury yields, as traders awaited December inflation data and weighed bets for quicker interest rate hikes by the Federal Reserve.
The dollar slipped after U.S. Federal Reserve Chair Jerome Powell's testimony before Congress did not spring any surprises in terms of monetary tightening, while a retreat in bond yields also lent support. Powell noted that policymakers were still debating approaches to reducing the Fed's balance sheet and said inflation is running very far above target and "it is a long road" to anything close to restrictive policy.
Peter Mooses, a senior market strategist at RJO Futures said economic uncertainty tied to the pandemic and volatility in wider markets also seemed to be helping safe-haven gold.
Gold firmed on Wednesday as data showing U.S. inflation was within expectations dented the dollar and prompted buying from investors who seemed to have priced in the Federal Reserve's likely interest rate hike trajectory.
Standard Chartered analyst Suki Cooper said gold prices have held up "remarkably well" even as the market continues to look for the first Fed rate hike in March.
Gold gained briefly after the release of data showing retail sales tumbled by 1.9% in December as Americans struggled with shortages of goods due to supply chain bottlenecks and an explosion of COVID-19 infections.
When the supply bottlenecks will be over?
In practice, the pandemic and recession are likely to have disrupted some productivity growth and destroyed some capacity semi-permanently, so spare capacity maybe even less than these figures suggest.
With the economy operating close to full capacity, but demand still increasing rapidly, inflationary pressures have accelerated significantly. If the economy is like a complex system or a machine, the rate-limiting factor or source of friction, in this case, is not the availability of labor but tightness in production capacity, energy, and other raw materials.
In the first nine months of 2021, the White House and Federal Reserve’s exclusive focus on the labor market blinded them to the increase in frictional pressures in other parts of the system. Policymakers attempted to use macroeconomic policy (low-interest rates, bond-buying, and government spending) to solve a microeconomic problem (persistent under-employment in sections of the labor force).
In April, White House advisers gave a lengthy press briefing in which they argued the economy could be run “hot” without “overheating”, but this has proved impossible. There is not enough manufacturing capacity, freight transportation capacity, oil, gas, and other raw materials to sustain the rapid rate of demand growth being fuelled by expansionary monetary and fiscal policies.
The resulting excess demand is showing up as rapid price increases across a broadening range of final products (furniture), semi-finished products (semiconductors), and raw materials (cotton). Now policymakers have a macroeconomic problem (too much demand) they are attempting to solve with microeconomic interventions (antitrust enforcement and targeted measures to support supply chains).
Prices will continue to escalate until aggregate demand is brought back into line with aggregate supply, either through slower demand growth, faster supply growth, or some combination of the two. In practice, there may be some scope to increase supply growth, but it is likely to be limited in the short term, which means most of the adjustment will have to come from slower growth in demand.
Ending central bank bond buying, higher interest rates, slower growth in government spending and tax rises will all likely be needed to moderate demand growth over the next two years and reduce inflationary pressure. The challenge for policymakers is to achieve a slowdown in demand growth, and inflation, without tipping the economy into a recession.
PIMCO writes in its recent report, concerning inflation and bottlenecks:
While the overall pace of core U.S. inflation in December 2021 remained strong, underlying details in the Consumer Price Index (CPI) data suggested some stabilization from the recent reacceleration. This reinforces PIMCO’s outlook for U.S. inflation to begin to moderate, likely peaking in February and then trending back toward the central bank’s target throughout 2022.
With inflation at multi-decade highs, upside risks to inflation expectations remain elevated. Taken together with the recent drop in U.S. unemployment, it is consistent with PIMCO’s expectations for the U.S. Federal Reserve to start to hike rates in March 2022 and move to further tighten policy by allowing the balance sheet to shrink later this year.
We continue to see upside risks supporting Fed officials’ decision to tighten policy more quickly than they previously projected. First, we continue to see upside risks to inflation expectations, as the longer inflation stays elevated, the greater the risk that consumers start to adjust their behavior. Second, we see risks from the recent global surge in COVID-19 cases related to the omicron variant. While we expect U.S. real GDP growth to slow in 1Q 2022 due to the virus outbreak as well as the breakdown in negotiations over the Build Back Better fiscal plan, we see risks that supply disruptions cause the inflation outlook for 2022 to rise further. Another disruption to production in China and other key U.S. suppliers would come at a time when U.S. retail goods inventories remain very low, raising the risk of an outsized impact from any further shutdowns.
As we do, PIMCO also sees direct relation between inflation and supply constraints. Thus, they write in their research, providing one of the possible scenarios:
Risk scenario #1: Inflation remains persistently elevated. Maybe 1) supply constraints don’t ease (or become worse due to additional COVID outbreaks), 2) the recently strong productivity growth trends (at least in the U.S.) sputter out, or 3) the incremental labor supply gains resulting from a recovery in prime-age participation and/or immigration don’t materialize. Or alternatively, it’s possible that inflation expectations rise as a result of the already elevated inflation prints, prompting stronger wage bargaining, which itself feeds into more persistent inflation.
Meantime, the bottlenecks keep bringing fruits. Last time we've mentioned rising prices by IKEA and Dollar Tree. This week Netflix raises prices for subscriptions by ~10% :
Netflix Inc has raised its monthly subscription price by $1 to $2 per month in the United States depending on the plan, the company said on Friday, to help pay for new programming to compete in the crowded streaming TV market. The standard plan, which allows for two simultaneous streams, now costs $15.49 per month, up from $13.99, in the United States. Prices also rose in Canada, where the standard plan climbed to C$16.49 from C$14.99.
To smooth the effect of delivery sabotage using Atlantic shipping, China adopts an alternative way of transition by ground as Russian Railways reports 35% growth of transition revenues:
Russian Railways saw a 34.4% jump to record high container volumes last year as it helped Asian manufacturers deliver goods to Europe amid a global logistics crisis, the state company said on Tuesday. Russia's transiting container traffic rose to 1.076 billion twenty-foot equivalent units (TEUs), the rail monopoly said in a statement.
Explosive growth in sea shipping costs is prompting Chinese manufacturers to send more goods to Europe by rail across Russia, but the growth in demand is creating bottlenecks and straining network capacity. With countries frantically replenishing stocks and exporting finished goods as they recover from the pandemic, global sea ports are snarling up, making rail an attractive alternative.
But transport operators and analysts say the rapid growth has exposed infrastructure problems that could limit transit flows significantly.
Meantime, China's economy likely grew at the slowest pace in 1-1/2 years in the fourth quarter, dragged by weaker demand due to a property downturn, curbs on debt and strict COVID-19 measures, raising heat on policymakers to roll out more easing steps.
Data on Monday is expected to show gross domestic product (GDP) grew 3.6% in October-December from a year earlier - the weakest pace since the second quarter of 2020 and slowing from 4.9% in the third quarter, a Reuters poll showed.
The world's second-largest economy, which cooled over the course of last year, faces multiple headwinds in 2022, including persistent property weakness and a fresh challenge from the recent local spread of the highly-contagious Omicron variant. China's economic growth is likely to slow to 5.2% in 2022, before steadying in 2023, a Reuters poll showed, as the central bank steadily ramps up policy easing to ward off a sharper downturn.
China's exports outperformed expectations for much of 2021, but shipments have been slowing as an overseas surge in demand for goods eases and high costs pressure exporters. It was unclear how the Omicron coronavirus variant would affect that trend.
Analysts polled by Reuters expect the central bank to deliver more modest easing steps, including cutting banks' reserve requirement ratios the one-year loan prime rate (LPR) - the benchmark lending rate. Analysts at ANZ said in a note that they saw a possibility that the central bank will cut the rate on its medium-term lending facility (MLF) on Monday.
Policymakers have also pledged to step up fiscal support for the economy, speeding up local government special bond issuance to spur infrastructure investment and planning more tax cuts.
The producer price index (PPI) climbed 10.3% from a year earlier, the data showed. Economists in a Reuters poll had expected the PPI index to gain 11.1% after a 12.9% rise in November. Factory inflation has moderated in recent months from a 26-year high in October as Beijing intervened to stabilize high raw material prices and ease an energy power crunch.
CFTC Report
This week we have a bit specific change in sentiment data as a lot of positions have been turned to "spreading" with a huge boost of interest rates. From the CFTC table we could see that although net long position increases for 11K contracts, mostly by closing shorts - the rest 39.6K stands for spreading positions. It could mean that market prepares to something, and traders try to avoid volatility in nearest time, to unlock positions later. It is difficult to say what particular reasons stand on the back, maybe geopolitical issues, but this bulk of locked positions shuold be put on one or another side relatively soon.
SPDR Fund also gives no hint on possible direction as reserves mostly stand flat despite rising price volatility:
Thus, based on information that we've got in recent two weeks, including statistics, Fed comments, and minutes we could suggest that more or less Fed aggressive policy is mostly priced-in already. This explains mild gold reaction on high inflation data, as well as no solid upside reaction after worse Retail Sales. Supposedly, the turning point was the publication of Fed minutes. Now, even four rate changes in 2022 are priced in already. If statistics remain stable within a couple of months, gold should get the room to breathe as the only major factor that could change the balance is the quantitative tightening program start and its pace. This question Fed intends to consider within a few meetings, and it is highly likely that no decision will be made until summer. Thus, within this period gold should keep chances to show upside retracement.
Once the Fed adjusts its policy closer to the end of 2022 and QT will be started, gold could get additional headwinds and the downside trend could be re-established again. Thus, in the 2nd half of 2022, we suggest domination of bearish sentiment on the market. While in a very long-term perspective, we keep our positive view on the gold market. In our opinion, the current situation in global finance is quite different from any other that we saw before. And it is a big chance that at some stage the contradiction between high inflation and fragile economic recovery appears. So that inflation remains high still, while Fed could have no chance to keep raising the rates as the economy starts to show signs of weakens. Even now, the US economic data is not very impressive. And here a lot depends on the US geopolitical strategy. We expect that tensions with Russia increases more, and if the US keeps the trade war against China - inflation can't be controlled by just Fed tools. Now the trade struggle brings mixed results. Indeed, the Chinese statistics become worse, but we do not see a strong impact by far. From a long-term perspective, we have more questions rather than answers but it is definitely could be said that either bottleneck disappears and the US should normalize trading with China, or the US inflation hardly could be defeated.
The gold market shows a bit different reaction on the recent bulk of statistics that we've got in two weeks. In general, reaction stands positive but not as strong as, say, on the FX market. This is because of the tight relation to interest rates. Despite relatively poor Retail Sales report, interest rates remain under pressure of two drivers - direct changing of the interest rates, which could start as soon as on March, and indirect rate increase that should be the by-product of the coming quantitative tightening program. These two moments do not let the interest market to "relax".
Market overview
Gold was flat on Monday, hovering near a three-week low, as traders awaited December U.S. inflation data that could reinforce the case for earlier-than-expected interest rate hikes by the U.S. Federal Reserve after weaker jobs data. Fed funds futures have priced an almost 90% chance of a rate hike in March and a more than 90% chance of another one by June.
An uptick in retail appetite for physical gold prompted dealers in India to charge premiums last week, while upcoming Lunar New Year festivities brightened the outlook for sales in Singapore. U.S.-Russia talks over rising tension in Ukraine also have traders on the edge, as the two sides seem far apart and failure risks an armed confrontation on Europe's doorstep.
Goldman Sachs expects the Fed to raise interest rates four times this year and begin the process of reducing the size of its balance sheet as soon as July. The investment bank, which earlier predicted the Fed would raise rates in March, June and September, now expects another hike in December.
Gold prices rose on Tuesday, supported by a weaker U.S. dollar and Treasury yields, as traders awaited December inflation data and weighed bets for quicker interest rate hikes by the Federal Reserve.
The dollar slipped after U.S. Federal Reserve Chair Jerome Powell's testimony before Congress did not spring any surprises in terms of monetary tightening, while a retreat in bond yields also lent support. Powell noted that policymakers were still debating approaches to reducing the Fed's balance sheet and said inflation is running very far above target and "it is a long road" to anything close to restrictive policy.
Peter Mooses, a senior market strategist at RJO Futures said economic uncertainty tied to the pandemic and volatility in wider markets also seemed to be helping safe-haven gold.
Gold firmed on Wednesday as data showing U.S. inflation was within expectations dented the dollar and prompted buying from investors who seemed to have priced in the Federal Reserve's likely interest rate hike trajectory.
Standard Chartered analyst Suki Cooper said gold prices have held up "remarkably well" even as the market continues to look for the first Fed rate hike in March.
Gold gained briefly after the release of data showing retail sales tumbled by 1.9% in December as Americans struggled with shortages of goods due to supply chain bottlenecks and an explosion of COVID-19 infections.
When the supply bottlenecks will be over?
- In December, there were still only 149 million non-farm jobs in the economy, compared with 157 million that would have been expected if employment had continued growing along with its pre-pandemic trend.
- The civilian labor force participation rate for those aged 25+ years was still only 62.8% in December compared with 64.5% in the same month in 2019.
- Real gross domestic product is just 2.5% below its pre-pandemic five-year trend. Real personal consumption expenditures are only 0.8% below trend.
- Total energy consumption was still 1.1% below track in the three months to September
- manufacturing production was already 2.9% above its anemic pre-pandemic trajectory by November.
In practice, the pandemic and recession are likely to have disrupted some productivity growth and destroyed some capacity semi-permanently, so spare capacity maybe even less than these figures suggest.
With the economy operating close to full capacity, but demand still increasing rapidly, inflationary pressures have accelerated significantly. If the economy is like a complex system or a machine, the rate-limiting factor or source of friction, in this case, is not the availability of labor but tightness in production capacity, energy, and other raw materials.
In the first nine months of 2021, the White House and Federal Reserve’s exclusive focus on the labor market blinded them to the increase in frictional pressures in other parts of the system. Policymakers attempted to use macroeconomic policy (low-interest rates, bond-buying, and government spending) to solve a microeconomic problem (persistent under-employment in sections of the labor force).
In April, White House advisers gave a lengthy press briefing in which they argued the economy could be run “hot” without “overheating”, but this has proved impossible. There is not enough manufacturing capacity, freight transportation capacity, oil, gas, and other raw materials to sustain the rapid rate of demand growth being fuelled by expansionary monetary and fiscal policies.
The resulting excess demand is showing up as rapid price increases across a broadening range of final products (furniture), semi-finished products (semiconductors), and raw materials (cotton). Now policymakers have a macroeconomic problem (too much demand) they are attempting to solve with microeconomic interventions (antitrust enforcement and targeted measures to support supply chains).
Prices will continue to escalate until aggregate demand is brought back into line with aggregate supply, either through slower demand growth, faster supply growth, or some combination of the two. In practice, there may be some scope to increase supply growth, but it is likely to be limited in the short term, which means most of the adjustment will have to come from slower growth in demand.
Ending central bank bond buying, higher interest rates, slower growth in government spending and tax rises will all likely be needed to moderate demand growth over the next two years and reduce inflationary pressure. The challenge for policymakers is to achieve a slowdown in demand growth, and inflation, without tipping the economy into a recession.
PIMCO writes in its recent report, concerning inflation and bottlenecks:
While the overall pace of core U.S. inflation in December 2021 remained strong, underlying details in the Consumer Price Index (CPI) data suggested some stabilization from the recent reacceleration. This reinforces PIMCO’s outlook for U.S. inflation to begin to moderate, likely peaking in February and then trending back toward the central bank’s target throughout 2022.
With inflation at multi-decade highs, upside risks to inflation expectations remain elevated. Taken together with the recent drop in U.S. unemployment, it is consistent with PIMCO’s expectations for the U.S. Federal Reserve to start to hike rates in March 2022 and move to further tighten policy by allowing the balance sheet to shrink later this year.
We continue to see upside risks supporting Fed officials’ decision to tighten policy more quickly than they previously projected. First, we continue to see upside risks to inflation expectations, as the longer inflation stays elevated, the greater the risk that consumers start to adjust their behavior. Second, we see risks from the recent global surge in COVID-19 cases related to the omicron variant. While we expect U.S. real GDP growth to slow in 1Q 2022 due to the virus outbreak as well as the breakdown in negotiations over the Build Back Better fiscal plan, we see risks that supply disruptions cause the inflation outlook for 2022 to rise further. Another disruption to production in China and other key U.S. suppliers would come at a time when U.S. retail goods inventories remain very low, raising the risk of an outsized impact from any further shutdowns.
As we do, PIMCO also sees direct relation between inflation and supply constraints. Thus, they write in their research, providing one of the possible scenarios:
Risk scenario #1: Inflation remains persistently elevated. Maybe 1) supply constraints don’t ease (or become worse due to additional COVID outbreaks), 2) the recently strong productivity growth trends (at least in the U.S.) sputter out, or 3) the incremental labor supply gains resulting from a recovery in prime-age participation and/or immigration don’t materialize. Or alternatively, it’s possible that inflation expectations rise as a result of the already elevated inflation prints, prompting stronger wage bargaining, which itself feeds into more persistent inflation.
Meantime, the bottlenecks keep bringing fruits. Last time we've mentioned rising prices by IKEA and Dollar Tree. This week Netflix raises prices for subscriptions by ~10% :
Netflix Inc has raised its monthly subscription price by $1 to $2 per month in the United States depending on the plan, the company said on Friday, to help pay for new programming to compete in the crowded streaming TV market. The standard plan, which allows for two simultaneous streams, now costs $15.49 per month, up from $13.99, in the United States. Prices also rose in Canada, where the standard plan climbed to C$16.49 from C$14.99.
To smooth the effect of delivery sabotage using Atlantic shipping, China adopts an alternative way of transition by ground as Russian Railways reports 35% growth of transition revenues:
Russian Railways saw a 34.4% jump to record high container volumes last year as it helped Asian manufacturers deliver goods to Europe amid a global logistics crisis, the state company said on Tuesday. Russia's transiting container traffic rose to 1.076 billion twenty-foot equivalent units (TEUs), the rail monopoly said in a statement.
Explosive growth in sea shipping costs is prompting Chinese manufacturers to send more goods to Europe by rail across Russia, but the growth in demand is creating bottlenecks and straining network capacity. With countries frantically replenishing stocks and exporting finished goods as they recover from the pandemic, global sea ports are snarling up, making rail an attractive alternative.
But transport operators and analysts say the rapid growth has exposed infrastructure problems that could limit transit flows significantly.
Meantime, China's economy likely grew at the slowest pace in 1-1/2 years in the fourth quarter, dragged by weaker demand due to a property downturn, curbs on debt and strict COVID-19 measures, raising heat on policymakers to roll out more easing steps.
Data on Monday is expected to show gross domestic product (GDP) grew 3.6% in October-December from a year earlier - the weakest pace since the second quarter of 2020 and slowing from 4.9% in the third quarter, a Reuters poll showed.
The world's second-largest economy, which cooled over the course of last year, faces multiple headwinds in 2022, including persistent property weakness and a fresh challenge from the recent local spread of the highly-contagious Omicron variant. China's economic growth is likely to slow to 5.2% in 2022, before steadying in 2023, a Reuters poll showed, as the central bank steadily ramps up policy easing to ward off a sharper downturn.
China's exports outperformed expectations for much of 2021, but shipments have been slowing as an overseas surge in demand for goods eases and high costs pressure exporters. It was unclear how the Omicron coronavirus variant would affect that trend.
Analysts polled by Reuters expect the central bank to deliver more modest easing steps, including cutting banks' reserve requirement ratios the one-year loan prime rate (LPR) - the benchmark lending rate. Analysts at ANZ said in a note that they saw a possibility that the central bank will cut the rate on its medium-term lending facility (MLF) on Monday.
Policymakers have also pledged to step up fiscal support for the economy, speeding up local government special bond issuance to spur infrastructure investment and planning more tax cuts.
The producer price index (PPI) climbed 10.3% from a year earlier, the data showed. Economists in a Reuters poll had expected the PPI index to gain 11.1% after a 12.9% rise in November. Factory inflation has moderated in recent months from a 26-year high in October as Beijing intervened to stabilize high raw material prices and ease an energy power crunch.
CFTC Report
This week we have a bit specific change in sentiment data as a lot of positions have been turned to "spreading" with a huge boost of interest rates. From the CFTC table we could see that although net long position increases for 11K contracts, mostly by closing shorts - the rest 39.6K stands for spreading positions. It could mean that market prepares to something, and traders try to avoid volatility in nearest time, to unlock positions later. It is difficult to say what particular reasons stand on the back, maybe geopolitical issues, but this bulk of locked positions shuold be put on one or another side relatively soon.
SPDR Fund also gives no hint on possible direction as reserves mostly stand flat despite rising price volatility:
Thus, based on information that we've got in recent two weeks, including statistics, Fed comments, and minutes we could suggest that more or less Fed aggressive policy is mostly priced-in already. This explains mild gold reaction on high inflation data, as well as no solid upside reaction after worse Retail Sales. Supposedly, the turning point was the publication of Fed minutes. Now, even four rate changes in 2022 are priced in already. If statistics remain stable within a couple of months, gold should get the room to breathe as the only major factor that could change the balance is the quantitative tightening program start and its pace. This question Fed intends to consider within a few meetings, and it is highly likely that no decision will be made until summer. Thus, within this period gold should keep chances to show upside retracement.
Once the Fed adjusts its policy closer to the end of 2022 and QT will be started, gold could get additional headwinds and the downside trend could be re-established again. Thus, in the 2nd half of 2022, we suggest domination of bearish sentiment on the market. While in a very long-term perspective, we keep our positive view on the gold market. In our opinion, the current situation in global finance is quite different from any other that we saw before. And it is a big chance that at some stage the contradiction between high inflation and fragile economic recovery appears. So that inflation remains high still, while Fed could have no chance to keep raising the rates as the economy starts to show signs of weakens. Even now, the US economic data is not very impressive. And here a lot depends on the US geopolitical strategy. We expect that tensions with Russia increases more, and if the US keeps the trade war against China - inflation can't be controlled by just Fed tools. Now the trade struggle brings mixed results. Indeed, the Chinese statistics become worse, but we do not see a strong impact by far. From a long-term perspective, we have more questions rather than answers but it is definitely could be said that either bottleneck disappears and the US should normalize trading with China, or the US inflation hardly could be defeated.
