While the white metal applauded the BOJ, the global liquidity drain intensified.
While silver rallies like QE awaits in 2023, the fundamental backdrop couldn’t be more different. For example, despite misreading inflation throughout 2021 and 2022, the consensus still believes a painless path to 2% will emerge in 2023.
However, with nine of the last 10 bouts of inflation since 1948 ending with recessions, market participants are uninformed about the challenges that lie ahead. For context, we wrote on Dec. 13 :
The crowd's misunderstanding of inflation has them assuming the pricing pressures will ease with little economic damage. But, history contrasts this sentiment, and one can argue that the pandemic-induced imbalances make this bout even worse. As such, pain should confront the believers when reality returns.
To that point, Bridgewater Associates’ Co-CIO Greg Jensen – who helps manage the world’s largest hedge fund – said on Dec. 15:
“There’s a lot of talk about recession, but very little recession priced in. You’re going to see relatively large moves as you shift from a world that’s fully focused on the Fed to one that’s focused on the recession and dollar squeeze that we see coming into the next year.”
Furthermore, while the consensus assumes that the end of China’s zero-COVID policy will uplift North American and European economies, Jensen noted that demand for cyclical commodities should worsen their inflation issues. He added:
“It’s been such a disinflationary force into a global inflation. China opening and the effect that’s going to have on commodity prices, in competing for raw materials in the world, while the US and Europe are entering recession, will probably make the central banking dilemma worse.”
As a result, while risk assets are priced for a mild deceleration in real GDP growth, the harsh realities of curbing unanchored inflation should result in a substantial sentiment shift in 2023.
Please see below:
Source: Bloomberg
To that point, while the crowd has swung and missed at three dovish pivot predictions in 2022, their misreading of inflation and the U.S. labor market highlights why peak FFR predictions kept accelerating. In contrast, the fundamentals have remained consistent with our expectations. We wrote on Aug. 1:
While the consensus assumes the Fed is near the end of its rate hike cycle, the Consumer Price Index (CPI) is on the fast track to 2% and a 3% FFR will be enough to capsize inflation, market participants are living in fantasy land.
For example, demand is much stronger than the consensus realizes. With Americans’ checking account balances at unprecedented all-time highs and the Atlanta Fed’s wage growth tracker hitting an all-time high in June, the FFR needs to go meaningfully above 3%. To explain, we wrote on Jul. 25:
With more earnings calls showcasing how the situation continues to worsen, market participants don’t realize that the U.S. federal funds rate needs to hit ~4.5% or more for the Fed to materially reduce inflation. For context, the consensus expects a figure in the 2.5% to 3.5% range.
So, while the prediction proved prescient, the crowd now assumes that instead of 2.5% to 3.5%, a ~5% FFR is the end of the hawkish road. However, the fundamentals do not support their dovish optimism.
Bank of America’s Chief Investment Strategist Michael Hartnett wrote on Dec. 16:
“Quicker labor markets break, quicker end to bear market, start new Wall St bull market.”
Thus, while he has a way with words, he’s been extremely accurate throughout this inflation cycle; and while we warned repeatedly that bear markets don’t end with the U.S. unemployment rate (UR) near a 50-year low, Hartnett noted that the average UR is 6.2% during that span, which is well above the current reading of 3.7%.
As a result, the Fed needs to “break” the U.S. labor market to break wage and output inflation, and we’re nowhere near that level of demand destruction.
Please see below:
To explain, Indeed updated its job postings data on Dec. 15. For context, it rebranded the metric as the “Indeed Job Postings Index,” and noted that the main difference is the scale, meaning “if the Job Postings Tracker were 40%, the corresponding Indeed Job Postings Index on the same date would be 140.”
Therefore, with the current index value at 148, U.S. job postings on Indeed are still 48% above their pre-pandemic level. Likewise, please focus your attention on the slope of the blue line. Despite 17 25 basis point rate hikes in 2022, the blue line has only declined marginally from its January peak. As it stands, the Fed has not broken the U.S. labor market, and a much higher FFR is needed to normalize inflation.
Moreover, while the S&P 500 may find short-term support amid bullish seasonality, the crowds’ optimism for a soft landing contrasts the harsh historical realities. Furthermore, with outsized market imbalances built up due to the unprecedented stimulus enacted in 2020, a material decline in GDP growth is required to offset that sugar high. In contrast, these issues are far from priced in, and a realization is profoundly bearish for the silver price.
Alex Demolitor
Precious Metals Strategist