The inflation rate accelerated again. It implies a more hawkish Fed and is bad for gold in the short-run, but good in the long-term.

Another inflation report – and another upside surprise! The CPI increased 1.3% in June, after rising 1% in May, according to the Bureau of Labor Statistics. As a reminder, we are talking here about monthly changes – not so long ago, such levels were reserved only for annual inflation rates! However, this was in the past, and the present reality is inflationary. The June rise was the steepest monthly increase since September 2005, but then it was a temporary spike, while now there is a clear upward trend, as the chart below shows.

The core CPI, which excludes food and energy, rose by 0.7% in June, after increasing by 0.6% in the preceding two months. Almost all major sub-indexes increased over the month, which indicates that inflation is broad-based.

If anyone hoped that the annual rates were better, I don’t have good news. Over the last 12 months, the CPI increased 9.1% in June, following an 8.5% increase in the previous month. It was the largest annual rise since November 1981, as the chart below shows. However, today’s situation is much worse, as inflation is still on the rise, while 1981 was a period of disinflation already. We still have to wait for the inflationary peak and the reverse in the trend.

Will Inflation Peak Soon?

We all wish for it, and there is a faint glimmer of hope: commodity prices have cooled recently, while the core CPI annual inflation rate was “only” 5.9% last month, following 6.0% in May and 6.1% in April. So, June was the second month in a row of a slower pace of core CPI inflation. However, the deceleration has been very modest so far, and below expectations, and the core CPI remains very high, which implies that inflation is well entrenched in the US economy.

What’s more, the Producer Price Index for finished goods is still accelerating, which suggests that consumer inflation won’t peak anytime soon. As the chart below shows, the PPI annual inflation rate jumped from 15.5% in April to 16.4% in May. Moreover, shelter inflation rose in June to 5.6%, the largest rate since February 1991, as one can see in the chart below.

Implications for Gold

What does it all mean for the gold market? Well, I’m tempted to write that the higher inflation, the better for gold. However, at this point, it should be clear that gold is not a simple inflation hedge. If this were true, the yellow metal would rally and already surpass $2,000, but it’s traded above $1,700 right now, as the chart below shows.

To be clear, trising inflation could be positive for gold as – given the economic slowdown – it implies that stagflation is coming. It could also upset the markets and boost the safe-haven demand for gold.

However, in the current environment, stubbornly high inflation implies a more hawkish Fed. As long as the US central bank delivers hikes in the federal funds rate, the markets don’t see inflation as a long-term problem. So, the more persistent inflation is, the more aggressive the tightening cycle could be. Indeed, according to the CME FedWatch Tool, the market-based probability that the FOMC will raise rates by 100 basis points at its July meeting has risen from literally zero last week to more than 80% after the CPI inflation report.

Is it unbelievable? Well, such a mammoth hike was just delivered by the Bank of Canada. So, the Fed can follow suit, and the more decisive actions of the US central bank, the higher interest rates. The higher interest rates, the stronger the dollar. Rising real interest rates and the appreciation of the US dollar are powerful headwinds for gold.

Not surprisingly, the yellow metal plunged yesterday to an intraday low of $1,704.50 within the first 15 minutes of trading in New York. However, it rebounded later to $1,744.30, but after all, the London price went down. It could further decline if hawkish expectations on interest rates strengthen. But the aggressive tightening will end in a hard landing, which should ultimately make gold shine.

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