Investors Unimpressed with Fed Chairman’s Double Talk on Inflation

The summer doldrums in precious metals markets have tested the patience of bulls. The silver market has been hit especially hard in recent weeks, but price stayed above the $24 level and avoided dipping to new lows for the year. 

Nervous and frustrated investors who bailed out this summer may have made a huge mistake. Gold and silver markets appear to now be catching a break on the upside. 

Metals markets stand to benefit from renewed weakness in the dollar. 

Since late May, U.S. dollar strength versus foreign currencies had put downward pressure on hard assets. The U.S. Dollar Index rallied from about 89.50 to just over 93 before momentum waned in recent days. 

The Index failed to make a new high for the year on its summer rally, setting the stage for a potential bearish reversal. That reversal appears to have taken place this week, with the Dollar Index breaking down below 92 yesterday.

Currency traders were unimpressed by the Federal Reserve’s latest policy briefing. On Wednesday, the Fed announced it would leave its benchmark Funds rate unchanged and continue its $120 billion in monthly asset purchases. 

No tapering was on the table, though there was some taper talk. It amounted to vague indications of future tightening after the U.S. economy attains "substantial further progress."

Fed Chairman Jerome Powell tried to quell inflation concerns. He reverted again to his “transitory” claims, but in remarks to the media he seemed confused about what his own definition of transitory inflation means. 

Jerome Powell: The increases will happen. We're not saying they will reverse. That's not what transitory means. It means that the increases in prices will happen. So, there will be inflation, but that the process of inflation will stop, so that there won't be ...

When we think of inflation, we really think of inflation going up year, upon year, upon year, upon year. That's inflation. When you have inflation for 12 months, or whatever it might be, I'm just taking an example, I'm not making an estimate, then you have a price increase, but you don't have an inflation process. And so, part of that just is that if it doesn't affect longer term inflation expectations, then it's very likely not to affect the process of inflation going forward.

So, what I mean by transitory is just something that doesn't leave a permanent mark on the inflation process. Again, I don't mean that producers are going to take those price increases back; that's not the idea. It's just that they won't go on indefinitely. We have two mandates, maximum employment and price stability. Price stability for us means inflation average of 2% over time. And so, we've got to be very careful about that, but I think it's a good point that it's a term, what it really means is "temporary." But then you've got to understand that it doesn't mean that the increases will be taken back. Some of them will be, but that's not really what it means.

Well, anyone wants to make sense out of all that would need a degree in Fedspeak. We are supposed to believe that stable prices actually means prices rising at a 2% average rate – except when the Fed wants inflation to run higher. But when it does, it’s only transitory – except when it affects the inflation process, which happens when long-term inflation expectations rise, which the Fed says won’t happen but at the same time doesn’t really know what will happen in the future.

Maybe what the Fed says matters less than what economic realities say. Investors would be better served focusing on fundamentals than trying to decipher central bankers’ forecasts.   

Unfortunately, investors can’t ignore the Fed entirely. Since its monetary policy decisions can and do drive financial markets, it is necessary to pay attention to what the Fed is actually doing.

Right now, it is still stimulating rather than fighting inflation, still holding interest rates artificially low, and still offloading negative real yields upon savers and investors. 

That puts both the bond and stock markets in precarious positions. If inflation expectations were to shift to rising prices being a long-term rather than a transitory problem, a dramatic downside readjustment in interest-rate sensitive financial assets would commence.

There would also likely be a dramatic upside revaluation of hard assets including precious metals. 

Whether investor psychology shifts suddenly or gradually toward an inflation-protection mindset remains to be seen. Metals markets tend to move slowly at the beginning of bull markets, then rapidly and even violently toward the end.

Market timing is an impossible task given the unpredictable nature of people and circumstances. What is possible is to capitalize on opportunities when markets are over-pricing financial assets and underpricing hard assets. 

The opportunity exists now, but it won’t last forever. There may even come a day when the opposite is true – hard assets are overpriced with inflation expectations running way ahead of actual inflation realities and financial assets offering tremendous value as a result. 

Yes, that could happen. It did in the early 1980s.

But the early 2020s look more like the start of a new inflationary cycle rather than the unwinding of one.

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