While the PMs remain elevated and optimism echoes, momentum investors have little use for medium-term technicals or fundamentals. However, with the Fed's hawkish agenda poised to collide with investors' over-positioning, the PMs should suffer mightily when the next bout of volatility erupts.
To explain, this week was filled with Fed officials urging investors to slow their roll. Whether it's Kashkari, Barkin, Waller, Bullard, Bostic, Daly, or Powell, they all warned about substantial interest rate increases over the next several months.
Furthermore, with the chorus expanding later in the week, Cleveland Fed President Loretta Mester said on Mar. 23 that investors should prepare for several rate hikes and quantitative tightening (QT) in the coming months.
“We have told the markets that we would let them know what the balance sheet process would look like,” said Mester. “I think given the situation we’re in and the communications that Chair Powell has already made about the balance-sheet process, I don’t have concerns that that would be destabilizing.”
Moreover, Mester expects 10 rate hikes by the end of 2022 (2.5% = 10 hikes of 0.25%).
Please see below:
Source: Bloomberg
Singing a similar tune, Chicago Fed President Charles Evans said on Mar. 24: “We want to be careful, we want to be humble and nimble, and get to neutral before too long – maybe 50 helps, I’m open to that.”
Either way, he added: “I would be comfortable with each meeting increasing by a quarter-point,” which implies six more rate hikes (seven in total) by the end of 2022.
Please see below:
Source: Bloomberg
As a result, we’ve had nine Fed officials tell investors this week that seven to 12 rate hikes are coming over the next nine months. While the financial markets have taken the hawkish rhetoric in stride, history implies that the fundamental implications contrast with the sanguine sentiment. To explain, I wrote on Mar. 23:
When Fed officials dial up the hawkish rhetoric, their “messaging” is supposed to shift investors’ expectations. As such, the threat of raising interest rates is often as impactful as actually doing it. However, when investors don’t listen, the Fed has to turn the hawkish dial up even more. If history is any indication, a calamity eventually unfolds.
Please see below:
To explain, the blue line above tracks the U.S. federal funds rate, while the various circles and notations above track the global crises that erupted during the Fed’s rate hike cycles. As a result, standard tightening periods often result in immense volatility.
However, with investors refusing to let asset prices fall, they’re forcing the Fed to accelerate its rate hikes to achieve its desired outcome (calm inflation). As such, the next several months could be a rate hike cycle on steroids.
To that point, investors may take solace in the belief that the Fed won’t follow through on its hawkish promises. As such, why not buy the PMs and front-run the Fed’s dovish pivot? However, I’ve warned for months that the U.S. economy remains in solid health. As a result, the probability of a dovish 180 continues to dwindle. For context, new U.S. home sales dipped on Mar. 23, as higher interest rates reduced demand.
Please see below:
However, the average selling price of a U.S. home increased to an all-time high of $511,000 in February. As a result, the shelter has never been more unfordable in the U.S., and lower-for-longer interest rates have been the primary driver of housing inflation.
Please see below:
(Click on image to enlarge)
Source: U.S. Census Bureau
Likewise, U.S. durable goods orders also slipped on Mar. 24. However, the decline followed four-consecutive months of gains.
Please see below:
More importantly, though, IHS Markit’s U.S. Composite PMI was the data point we waited for all week. For context, IHS Markit completed its merger with S&P Global, so the data goes by the latter’s name now. However, with the data acting as a leading indicator of U.S. economic activity, the results often predict the direction of future U.S. government data.
What was the verdict? Well, aligning with what I’ve been warning about for many months, S&P Global’s U.S. Composite PMI increased from 55.9 in February to 58.5 in March, as “manufacturers and service providers registered stronger upturns in activity, largely supported by pent-up demand and the easing of COVID-19 restrictions.”
Please see below:
On top of that, the report revealed:
"March data showed a marked rise in new orders at businesses, as an upturn in client demand strengthened for the second month running to reach a nine-month high…. Alongside more favorable domestic demand conditions, new export orders rose at a quicker pace at the end of the first quarter."
In addition:
"The rate of overall job creation was the sharpest since April 2021, as manufacturers and service providers alike recorded steeper upturns in employment."
Moreover, with resilient demand colliding with rising commodity prices, the inflationary results still contrast with the Fed's goals.
Please see below:
Source: S&P Global
In addition, while the U.S. service sector has lagged manufacturing due to the restrictions imposed during the spread of the Delta and Omicron variants, many U.S. states have abandoned their COVID-19 policies. As a result, services are gaining momentum and have grabbed the inflationary baton.
Please see below:
Source: S&P Global
As a result, does this seem like an economic environment where the Fed will refrain from raising interest rates? As further evidence, the Kanas City Fed released its Tenth District Manufacturing Activity Survey on Mar. 24., and with the headline index increasing from 29 in February to 37 in March, the report revealed that “Tenth District manufacturing activity reported record high growth and expectations for future activity remained solid.”
Please see below:
Source: KC Fed
Moreover, the KC Fed’s prices paid index increased from 64 in February to 81 in March, while its prices received index increased from 47 to 51. As a result, inflation trends are not moving in the Fed’s desired direction.
Please see below:
(Click on image to enlarge)
Source: KC Fed
On top of that, not only did current inflationary pressures increase month-over-month (MoM) in March, but the KC Fed’s index of manufacturers’ six-month expectations for prices received increased to an all-time high of 75.
Please see below:
(Click on image to enlarge)
Source: KC Fed
Finally, the U.S. Department of Labor (DOL) released its weekly unemployment data on Mar. 24. With initial unemployment claims hitting a new post-pandemic low of 187,000, the U.S. labor market also meets the Fed’s threshold to raise interest rates.
Source: DOL
The bottom line? While some investors think that the Fed is all bark and no bite, the data suggests otherwise. With demand resilient, inflation abundant, unemployment falling, and Fed officials warning of coming rate hikes, the next several months should elicit plenty of hawkish fireworks.
Likewise, the data we received this week shows that inflation is still increasing MoM. Moreover, the PMI report from S&P Global shows that U.S. economic activity has also strengthened MoM. Furthermore, with the warm weather approaching, the summer months should increase consumer mobility and foster stronger economic growth relative to the winter periods. As such, the good news should continue to flow, and that’s bullish for hawkish Fed policy, the USD Index, and U.S. Treasury yields, and bearish for the PMs.
What to Watch for Next Week
With another full slate of U.S. economic data releases next week, the most important ones are as follows:
- Mar. 28: Dallas Fed manufacturing index
Like the data covered above, the Dallas Fed manufacturing index will let us know how output, employment, and inflation are behaving in Texas.
- Mar. 29: The Confidence Board consumer confidence, JOLT job openings, Dallas Fed services index
With interest rates on the rise and inflation still raging, it will be interesting to see how the dynamics have affected consumers' psyches as well as businesses' hiring expectations. Likewise, the data from the Dallas Fed will provide a window into the service sector recovery in Texas.
- Mar. 30: ADP employment, Q4 GDP
While ADP's data is often a poor predictor of U.S. nonfarm payrolls, it still provides valuable insights into private employers' hiring activity. In addition, Q4 GDP is a lagging indicator, and investors are forward-looking. As a result, the data isn't as impactful as the monthly surveys. However, it's still important to monitor.
- Mar. 31: PCE Index, Challenger job cuts, Chicago PMI
The PCE Index is the Fed's primary inflation gauge, so more hot prints will only increase officials' hawkish dispositions. Likewise, Challenger job cuts will let us know how many U.S. citizens have lost their jobs, while the Chicago PMI will let us know how output, employment, and inflation are behaving in Illinois.
- Apr. 1: U.S. nonfarm payrolls, ISM manufacturing PMI
Like the PCE Index, continued outperformance of U.S. nonfarm payrolls will only increase Fed officials' hawkish estimates. In addition, it will be interesting to see if ISM's manufacturing PMI confirms or contrasts with S&P Global's data outlined above.
All in all, economic data releases impact the PMs because they impact monetary policy. Moreover, if we continue to see higher employment and inflation, the Fed should keep its foot on the hawkish accelerator. If that occurs, the outcome is profoundly bearish for the PMs.
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