The white metal’s dreams of rate cuts and QE should become fundamental nightmares.
While the silver enthusiasts see another round of QE sparking the next bull market, the expectations lack fundamental credibility. For example, the Fed’s balance sheet remains on a downward path, nearly erasing the bank run rise.
Please see below:
To explain, while the metric was largely flat this week, it’s been declining since peaking in late March, and continued QT should be the primary theme going forward.
Likewise, while the crowd still expects cuts, the projected FFR has stabilized at higher levels.
Please see below:
To explain, the red line above tracks the December 2023 Federal Funds Futures contract. And since the yield moves inversely to the price, the drop on the right side of the chart highlights how a hawkish shift has overcome the bank fears. But, with more room to run, we expect the metric to continue its descent over the medium term.
Speaking of which, the IMF’s Managing Director Kristalina Georgieva told CNBC on Jun. 4:
“We don’t yet see a significant slowdown in lending. There is some, but not on the scale that would lead to the Fed stepping back.”
As a result, even she recognizes that the ‘bank crisis’ has done little to disrupt economic activity. And with that, it has done little to help the Fed achieve its goals.
Please see below:
The Big 3: Growth, Employment and Inflation
While we noted the U.S. Services PMI's strength, the outperformance is present worldwide. The S&P Global/JPMorgan Global Composite PMI increased from 54.2 in April to 54.4 in May, and an excerpt read:
“The service sector outperformed manufacturing again during May, with growth of services activity accelerating to its best since November 2021. Although growth of manufacturing production was subdued in comparison, the rate of expansion still improved to an 11-month high.
“All six of the sub-sectors covered by the survey – business services, consumer goods, consumer services, financial services, intermediate goods and investment goods – registered output growth in May…. All 13 of the countries for which combined manufacturing and services PMI data were available for saw output increase during May.”
Thus, while the bond bulls remain eager to buy the dip, interest rates are too low to slow demand and curb inflation. Consequently, the consensus narrative should shift when the crowds’ faulty expectations confront reality.
Please see below:
In addition, the Conference Board released its Employment Trends Index (ETI) on Jun. 5. The metric remained roughly flat at 116.15. Selcuk Eren, Senior Economist at The Conference Board, said:
“We remain in a very tight labor market, especially compared to pre-pandemic conditions. Job growth continues economy-wide, with in-person service sectors leading the way. Industries that have yet to fully recover from the pandemic – including leisure and hospitality, along with the government sector – are poised to continue adding jobs, while an aging U.S. population will fuel sustained employment growth in the healthcare and social assistance industry….
“Wage growth is slowing down but remains above its pre-pandemic rate. We expect the Federal Reserve will raise interest rates at least one more time by 25 basis points, to slow wage growth and reduce inflationary pressures.”
So, while the crowd expects more helicopter money, The Conference Board sees the FFR rising, not falling.
Please see below:
Finally, interest rate and inflation expectations are the primary fundamental drivers uplifting the silver price. Moreover, they also impact the USD Index, as they help shape rate-hike/cut expectations. And with the crowd believing the yield rise has run its course, the narrative helps support the PMs.
Please see below:
To explain, the blue line above tracks the swaptions (options on swap contracts) skew. In a nutshell: when the blue line rises, it’s more expensive to pay a one-year fixed interest rate and receive a one-year floating interest rate (crowd expects higher rates). Conversely, the drop on the right side of the chart shows how the relationship has flipped, which highlights how many expect short-term yields to fall and few expect them to rise.
Yet, we believe this assumption is shortsighted, and the neutral interest rate is higher than what’s currently priced in. Therefore, with the BoC already sounding the hawkish alarm, we believe the Fed will confront similar realities in the months ahead.
Overall, while gold, silver and mining stocks hope to front-run rate cuts and QE, little has been done to achieve the Fed’s objectives. As such, investors’ expectations contrast the fundamentals, and the latter should emerge victorious in the end.
Do you agree with the IMF, or will the Fed reverse course like the consensus expects?
Alex Demolitor
Precious Metals Strategist