Gold's recent exploits have whetted the appetite of investors. However, the outlook for the dollar remains healthy. That can only mean one thing.
As volatility erupts in financial markets, gold andsilver pricesthey are pulled in contradictory directions. For example, with the USD index suffering a short-term decline, the outcome for precious metals is fundamentally bullish. However, given rising US Treasury yields, the result is generally low.Oroand silver prices. So, as the broader stock market faces panic buying and selling, PMs deal with these cross currents.
However,With QE on its deathbed and the Fed set to raise the fed funds rate in the coming months, rising real rates are the common denominator.To explain, the recent popularity of the euro has impacted the dollar index. For context, the EUR/USD represents almost 58% of the movement of the basket of dollars. So if real interest rates go up and the US dollar goes down, what will happen to PMs?
well the reality iswhat comes up real interest are bullish on the USD index,and the recent ECB-induced recovery of the euro is not surprising. As investors often bought EUR/USD in anticipation of an aggressive move by the ECB, another 'hopeful' bounce ensued. However, the central bank continued to disappoint investors in 2021 and the currency pair continued to hit new lows. Therefore, we expect the downward trend to continue in the medium term.
In support of our expectations, on February 2 I wrote the following about the financial situation and the USD index:
To explain, the blue line above represents the Goldman Sachs Financial Conditions Index (FCI). For context, the index is calculated as a "weighted average of risk-free interest rates, exchange rates, equity valuations, and credit spreads, with weights corresponding to the direct impact of each variable on GDP." In short, when interest rates rise along with credit spreads, it becomes more expensive to borrow money and financial conditions tighten.
Up to this point you can see that if you look at the right hand side of the graphthe FCI has exceeded its pre-COVID-19 maximum(January 2020). Furthermore, the FCI bottomed out in January 2021 and has been chasing a comeback ever since. Not coincidentally, the PMs have suffered greatly since January 2021. At this point, with the Fed set to raise rates at its March policy meeting, the FCI should continue to rise. As a result, aid rallies by prime ministers must stop, just like in 2021.
Also,Although the USD index has fallen from its recent high, it is no coincidence that the basket of dollars bottomed out in January 2021 with the FCI and reached a new high in January 2022 with the FCI.While the recent consolidation may seem worrisome, the medium-term fundamentals that support the dollar remain strong.
In addition, tighter financing conditions are often a consequence of rising real interest rates. As mentioned above, the USD index bottomed out at the FCI and rose to new highs at the FCI. As a result, fundamentals support a stronger USD index, not a weaker one. As evidence, the US 10-year real yield, the FCI, and the USD index have followed similar paths since January 2020.
To explain, the green line above represents the USD index since January 2020, while the red line above represents the 10-year US real yield. While the latter did not bottom out like the USD and FCI index did in January 2021 (although it was close), all three rallied sharply at the end of 2021 and hit new highs in 2022.Nominal and real yields on 10-year US Treasuries hit new 2022 highs on February 1.
Also, if you compare the two charts, you'll see that all three metrics increased when the coronavirus crisis hit in March 2020. Thus, the trio often follows in each other's footsteps. Given that the Fed is likely to raise rates at its March policy meeting, this conclusion supports higher US 10-year real yields and a higher FCI. Consequence,The fundamentals underlying the USD index remain strong and near-term sentiment is likely to explain the recent weakness.
With the Omicron variant slowing US economic activity, the "bad news is good news" camp has raised new hope for a dovish Fed. However, the recent stress is unlikely to affect the Fed's response function. Case in point: After ADP private payrolls fell 301,000 in January (data released Feb. 2), concern spread across the Wall Street. However, after US Nonfarm Payrolls (government data) came in at 467,000 vs. 150,000 expected on February 4, the US labor market remains extremely healthy.
Quelle: US Bureau of Labor Statistics (BLS)
Additionally, the BLS revealed that “the monthly job change for November and December 2021 combined is 709,000 higher than previously reported, while the monthly job change for June and July 2021 combined is 807,000 lower.Overall, the change over the year 2021 is 217,000 more than previously reported."
Thus, in November and December combined, the US created more than 700,000 jobs than previously reported, and net income in 2021 was more than 200,000.
As for wage inflation, the BLS also revealed:
“In January, the median hourly wage for all employees on private nonfarm payrolls increased 23 cents to $31.63.Over the past 12 months, average hourly earnings have increased 5.7 percent."
As a reminder, as investors speculate on the prospect of a hawkish ECB, the latest release from Europe shows that wage inflation is much weaker than in the US. To explain this, I wrote on February 1:
Hourly labor costs in the Eurozone increased by 2.5% year-on-year on December 16 (latest report). Furthermore, the report revealed that“The cost of wages and hourly wages increased by 2.3%, while non-wage labor costs increased by 3.0% in the third quarter of 2021 compared to the same quarter of the previous year.
As a result, non-wage labor costs such as insurance, health care, unemployment insurance, etc. - supported most of the weight. By contrast,Wage inflation is far from the ECB's danger zone.
And why is wage inflation so critical? Well, the ECB's chief economist, Philip Lane, said on January 25:
Consequence,If the ECB's chief economist says that wage inflation needs to hit 3% yoy to be "consistent" with the ECB's 2% yoy inflation target, then 2.3% yoy wage growth is far from problematic.While euro bulls expect the ECB to mirror the Fed and run an aggressive 180, the data suggests otherwise.
Furthermore, while the USNon-farm payrollsClearly overtaken by February 4, I noticed that February 2There are now 4.606 million more jobs in the US than there are unemployed citizens.
To explain, the green line above subtracts the number of unemployed US citizens from the number of job openings in the US. If you look at the right hand side of the graph, you can see that the epic crash has been completely reversed and the green line is now is at its highest point. With more jobs available than people looking for work, the economic environment supports Fed normalization.
So when we put the puzzle together,the US labor market remains healthy and US inflation is performing significantly better than in the Eurozone.As a result, the Fed should stay ahead of the ECB and aggressive performance argues for a weaker EURUSD and a stronger USD index. Additionally, the momentum also supports a higher FCI and a higher 10-year US real.production. As we have seen since January 2021, these fundamental results are extremely hostile to PMs.
While the Omicron variant weighed heavily on economic sentiment, I noted earlier that the outages are likely to be short-lived. For example,With Americans fearing a recession from COVID-19, the renewed economic strength should keep pressure on the Federal Reserve.
As an explanation, the light brown line above shows the net percentage of Americans concerned about COVID-19, while the dark brown line above tracks Kayak's changing flight search trends. In short, the greater the concern about COVID-19 (a tall tan line), the more Americans shudder and avoid travel (a low dark brown line).
However, if you look at the right side of the graph, you can see that the light brown line has overflowed and the dark brown line has increased significantly. With the trend likely to continue in warmer weather, greater mobility should boost confidence, support economic growth and keep the Fed's rate hike cycle on track.
The bottom line? the dollar indexFundamentalsthey remain extremely healthy, and while near-term sentiment has been hostile, rising real yields and a hawkish Fed should continue to provide support over the medium term. Also, since PMs often move inversely against the US dollar, gold, silver and mining stocks are likely to suffer further losses in the coming months.
In short, prime ministers rallied on February 4 despite rising US Treasury yields. However, with the broader stock market facing so much volatility of late, sentiment has led PMs in various directions. It is important, however, that the medium-term thesis be maintained:USD Index and US Treasury yields should be looking for higher bottoms and realization is deep for the precious metals sector.
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Von Przemysław Radomski, CFA
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