As payrolls push higher, follow-through from the U.S. federal funds rate (FFR) could reignite the yellow metal’s bear market.
With U.S. nonfarm payrolls outperforming economists’ consensus estimate on Dec. 2, the U.S. labor market continues to defy expectations. Moreover, with employment gains poised to uplift the FFR, the fundamentals remain bullish for real yields and the USD Index.
Please see below:
Source: Investing.com
Furthermore, the labor force participation rate (LFPR) declined from 62.2% in October to 62.1% in November. As a result, more Americans left the workforce in November, and I’ve warned on numerous occasions that the development is highly inflationary.
To that point, with the LFPR declining for the third month in a row, the metric is far from its pre-pandemic peak.
Please see below:
To explain, the red line above tracks the LFPR, and if you analyze the right side of the chart, you can see that comfortable cash cushions have enabled Americans to exit the workforce. So, the lack of normalization is bullish for wage inflation, and the consequences are still underestimated by market participants.
Therefore, with average hourly earnings (AHE) substantially outperforming expectations on Dec. 2, the fundamentals continue to unfold as expected.
Please see below:
Source: Investing.com
To explain, AHE increased by 0.8% month-over-month (MoM) in November, which was more than double the consensus estimate of 0.3% MoM. Likewise, the 5.1% year-over-year (YoY) increase also surpassed the 4.6% YoY estimate.
As such, while the pivot crowd (led by ZeroHedge) has been wrong about growth and employment for many months, the most recent theory was that the U.S. labor market would collapse after the midterm elections. In a nutshell: the Democrats would have no reason to hide the poor results any longer.
Please see below:
Yet, while the list of theories grows longer, the U.S. labor market continues to outperform, and investors are missing the forest through the trees.
Now, the price action on Dec. 2 suggested the exact opposite. For example, while the GDXJ ETF and the S&P 500 opened materially lower, they rallied intraday and closed near their highs. Conversely, the USD Index popped on the payrolls news, only to sell off as the risk rally ensued. Furthermore, the U.S. 10-Year real yield declined as the breakeven inflation rate rose and the nominal rate declined.
Consequently, while the fundamentals have been spot on and the thesis remains surgical, the price action has not followed suit. So, what gives?
Well, while historical mistakes should be enough to shake them, investors still have full faith in Fed Chairman Jerome Powell; and despite his many errors over the last ~ two years, when he preaches patience and signals a “slowdown” in rate hikes in December, investors (in the short term) care more about what he says than fundamental reality.
For example, please read this headline from Jul. 15, 2021:
Source: NASDAQ.com
The article stated:
“The Fed controls short-term rates directly, and longer-term rates indirectly, but those longer-term rates are set by the market on a day-to-day basis. If traders believed that inflation was really taking hold and would force a rate hike before the Fed’s predictions of more than a year from now, the 10-Year Treasury yield would not have fallen from around 1.75% in March to its current 1.3%.
“Again, the money is saying, shouting even, that neither the 5.4% annualized CPI growth, nor the 4.5% jump in the Fed’s preferred ‘core inflation’ metric reported this week, will be sustained for long enough to force a reaction in rates.”
Thus, despite all of the “shouting” about transitory inflation in the summer of 2021, do you remember what I wrote on Jul. 15, 2021?
With Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), telling Congress on Jul. 14 that the U.S. economy is “still a ways off,” investors rejoiced as the rhetoric implies that tapering is “still a ways off.” However, while Powell repeated his classic lines and maintained his classic stance, his short-term suppression of U.S. Treasury yields and the USD Index will likely result in even more violent upswings over the medium term….
Moreover, while taunting inflation may seem amusing in the short run, the Fed’s nonchalance will likely result in an even faster taper once the pressure mounts; and with gold’s largest 2021 daily loss more than 1.58x its largest daily gain, the precious metals will likely run for cover once the drama unfolds.
Likewise, we find ourselves in the same situation. With investors more focused on what Powell says than what’s actually happening, they willfully follow his lead even though he has been woefully wrong. So, while the fundamentals are highly bullish for the FFR, real yields and the USD Index, the crowd that bought the U.S. 10-Year Treasury yield at 1.3% in the summer of 2021 is the same crowd buying the PMs and selling the U.S. dollar now.
As a result, don’t be surprised if the same misguided narrative uplifting risks assets implodes in the months ahead.
Alex Demolitor
Precious Metals Strategist