After a flurry of major central bank meetings and a strong US jobs report this month, markets have calmed down, with equity volatility measures near their long-term lows.
The dollar has perked up and has reached fresh highs against low-yielding currencies such as the euro and Japanese yen. This is chiefly due to increasing price pressures, which have been highlighted again by strong and persistent inflation figures out of the US.
In turn, money markets are pricing in the chances that the US Federal Reserve has to raise interest rates sooner than expected.
In contrast to the soft patch witnessed in the third quarter in economic data, there have been some eye-catching economic releases recently.
This includes the very solid US monthly non-farm payrolls report, which had notable prior month upwards revisions. Last week’s US retail sales also beat expectations and points to household incomes and wealth that are still rising.
This should see consumers continue to drive the economy during the final quarter of the year, with gross domestic product in the last three months of the year projected to print a very healthy 6 per cent.
The upside surprise in the US October inflation data probably grabbed the most headlines, particularly the attention of monetary policymakers around the world who will be feeling under more pressure to tighten policy and raise interest rates.
The US Consumer Price Index outcome for October hit an annual rate of 6.2 per cent, a new three-decade high and three times the Federal Reserve’s medium-term target of 2 per cent. In addition, there was breadth to the above, with the core reading that strips out more volatile food and energy costs climbing to 4.6 per cent.
Bond markets, which price in the potential interest rate moves of central banks, reacted swiftly to the bumper inflation data release.
Expectations of the first US rate rise have now moved to the middle of next year from 2023. Traders believe inflation will remain persistent for a prolonged period, forcing the Fed into action by raising rates soon after tapering its bond-buying programme.
We are now also seeing more Fed officials shift their “transitory” views as they take the inflation challenge more seriously. Essentially, we have inflation at a 31-year high, while rates are at their lowest they’ve ever been.
One interesting thing to note here is that the timing of interest rate moves has been brought forward, but rate hike pricing for 2023 and 2024 remains little changed.
Using the 10-year US Treasury yield as a predictor of the peak US Fed funds rate for this cycle, forecasts remain very modest with the current yield of 1.6 per cent well below the Fed’s long-term projection of 2.5 per cent.
The issue taxing many economists is how far prices might rise. Some believe we could see headline inflation above 7 per cent as pipeline price pressures show little sign of diminishing and expectations for inflation climb higher.
But other analysts hope that the year-on-year impact of higher energy prices especially, will start to fade in time, while other raw material shortages ease. In many ways, this is a similar scenario to the inflationary spikes before the financial crisis in 2008 and around the turn of the millennium.
One asset enjoying the current environment has been gold, with the precious metal making fresh five-month highs in recent sessions. The commodity is traditionally seen as an inflation hedge and would also benefit in periods of lower growth and higher inflation. This is so-called “stagflation” and fears that the global economy could be entering this phase are growing.
Of course, higher global interest rates do reduce the appeal of holding a non-interest-bearing asset like gold.
A rising dollar should also dull the appeal of the precious metal. But central banks are not expected to raise rates so fast as to choke off the growing recovery.
This has led to real interest rates, that is those adjusted for inflation, remaining in deeply negative territory, which is definitely attractive for gold bugs and those positioning for a more inflationary environment. Moderate inflation should mean a preference towards equities and away from bonds, while stronger levels point to precious metals and other commodities.
There is strong price support for gold at $1,834, with the June high at $1,917 a target for the bulls. Key will be whether we are close to a top in inflation expectations, which could signal that real yields start to rise again and dull gold’s appeal.
Hussein Sayed is the chief market strategist at Exinity Group