June 2023 - Week 2 Edition

Gold Rallies on News of Interest Rate ‘Pause’

The “morning after” (Thursday, June 15) the Federal Reserve’s momentous interest rate “pause,” along with a dismal footnote of possible increases to come, was a sunny morning in most markets. Stocks are recovering, and so is gold, which rose $20 – from $1,930 to $1,950 – in the first two hours of trading on Thursday. Earlier in the week, gold dipped on Monday and Tuesday and then rallied early Wednesday, as the Federal Reserve met in one of their 8-times-per-year Federal Open Market Committees (FOMCs), to debate interest rate policies. In anticipation of a possible pause in rate hikes after 10 consecutive increases, totaling 5%, the U.S. Dollar Index had fallen 1.3% in the previous week (June 7-14). Subdued inflation reports released this week gave the Fed additional “cause for pause.” Since May and June 2022 marked peak inflation growth rates last year, May and June 2023 would “wipe out” those two peak months and push 12-month rates lower.

This week, we recap the two key inflation reports, the Fed’s actions and the market’s reaction.

May Inflation Figures Were Muted Due to Peak Inflation Rates Last May and June

The Consumer Price Inflation (CPI) for May was released on Tuesday, when the U.S. Labor Department announced that consumer prices rose only 0.1% in May, down from April’s 0.4%. The “core” rate (subtracting food and energy) rose 0.4% (a 5% annual rate). On a 12-month basis, the CPI slowed down to a +4% rate, the lowest since March 2021, and is now less than half of last June’s peak rate of +9.1%. However, the 12-month “core” rate remained elevated, at +5.3%.

The difference between the headline rate (4%) and core rate (5.3%) is due to the fact that energy prices fell for the third time in four months, falling by 3.6% in May and 7.0% over the past year, while food prices rose just 0.2%, following zero growth in each of the previous two months.

Still, food costs remain 6.7% higher than a year ago, offsetting the 7% decline in energy costs in the same 12 months. Within the energy sector, fuel oil is down 37% (year over year), and gasoline prices are down 19.7% vs. a +60% annual increase in gas last June, the worst rise since 1980.

This inflation rate decline is mostly a result of the Fed ratcheting down their M2 Money Supply over the past year by over $1 trillion while raising interest rates at the fastest pace in history. This proves once again that inflation is fueled by too much money and the only cure is to withdraw some of that money, as Fed Chairman Paul Volcker did in 1979-80, pushing gold sky high.

The Producer Price Index (PPI) came out Wednesday morning and its decline was even steeper than the CPI, implying more rapid CPI declines in future months.  Month over month, producer prices fell 0.3% in May, the fourth decline in the past six months. The producer price increase in the most recent 12 months, ending May 31, 2023, was just 1.1%, compared with the 2.3% 12-month rise through the end of April.  This was credited to sharp declines in energy and food prices, which have caused the PPI annual rate to decelerate for 11 straight months since peaking in June 2022. The PPI recorded its lowest reading since December 2020, as we emerged from peak COVID.

How the Federal Reserve Reacted to This Inflation News on Wednesday

The Fed had time to weigh both inflation reports before announcing their interest rate decision. Over the past 10 FOMC meetings, the Fed has been overly “reactionary” to the lagging inflation indicators without anticipating the future. Since inflation peaked in June 2022, next month’s June numbers (released in mid-July) will probably be even more subdued, so the Fed is right to refrain from raising rates this week. Still, as of last week, the investment community was still uncertain.

One week ago (on June 7), 27.5% of investors (bettors) – on the Chicago Mercantile Exchange (CME) FedWatch Tool – thought that the Fed would raise rates by 0.25% on June 14. That betting line was down to 6.9% on Tuesday, June 3, after the release of the Consumer Price Index data, and it declined further to just 2.3% on Wednesday morning, after the release of the PPI data.

Early Wednesday, before the Fed made their announcement, gold and silver rose, while the stock market was nervous, betting on a “pause,” but concerned about the Fed “statement” on future rate increases. Sure enough, the majority of the 18 voting Fed members were generally “hawkish,” with the majority calling for two or more rate hikes later this year. That news caused an immediate earthquake in most markets. The Dow was already down 150 points before the news broke and it fell another 150 points within minutes. The Dow was down 428 at its lowest point but then it rallied, closing down only 232 points (and it is up over 200 points on Thursday). The S&P 500 rose Wednesday, by the closing bell. Gold dropped $15 on the news, then rallied but dropped again. Treasury rates rose sharply at first but then settled back, as most markets tend to overreact – shooting first, then aiming as traders like to “beat the crowd.”

The most chilling news was that nine of the 18 voting members voted for two more rate hikes this year and three voted for three or four more increases. The Chairman implied that “two more increases” (of 0.25% each) will likely happen, but that will depend on future data.

Thirty minutes after the Fed’s announcement, Chairman Jerome Powell held his press conference, after which there is often a more severe market reaction if the dour Chairman misspeaks himself. He has learned after making many past blunders, so he has been more careful not to stick his foot in his mouth too often. As it turned out, he performed well, hence the recovery in stock and bond markets, and the gold market Thursday, as traders tend to overreact on trivial Fed word choices. Be sure to contact your professional account representative today to find out how you can add gold to your investment plans.

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