When U.S. Inflation is Bad for Inflation-Sensitive Assets
Inflation pressure in the United States is pushing up interest rates.
Rising interest rates, in turn, are sucking capital into U.S. Treasuries, which have significantly higher yields on offer than the government debt offerings of other countries.
The capital coming into U.S. Treasuries then strengthens the U.S. dollar — to buy USTs is to buy a dollar-denominated asset, which means buying dollars by default — which in turn makes U.S. Treasuries that much more attractive by way of currency appreciation.
When an overseas investor buys U.S. Treasuries today, they get currency appreciation (via strengthening dollar) and higher yields (via U.S. Treasuries) at the same time.
This dynamic — which is part of the Imperial Circle, a model of debt-financed growth creating the wherewithal to withstand higher interest rates — is creating a feedback loop that is bad for inflation-sensitive assets.
The presence of U.S. inflation against a robust economic backdrop creates a counter-reaction in the form of higher yields... which fuels a stronger dollar by sucking in capital... which puts pressure on gold and silver and the like.
You can see the effect in real-time via the US dollar index, which recently surged:
And also via silver, which looks ready for a new leg down:
Meanwhile gold is under pressure too:
And Bitcoin is testing multi-month lows at $60,000 support:
We would further argue that, prior to current signals of breakdown, the strength exhibited in March by silver, gold, and Bitcoin was mostly speculative.
By that meaning message board investors, China-based futures traders and the like were assuming that either the Fed was in a hurry to cut rates... or that some version of "printing press go brr" still applied... or that inflation pressure would be negative for the dollar… or a combination of all three.
One question to ask here is, "what keeps the dollar from getting stronger?"
China is still fighting a deflation shock, and may ultimately be forced to devalue its currency, which is pegged at an overvalued level relative to China's economic prospects.
If a China devaluation happens, U.S. dollar strength would reach a whole new level.
Europe, meanwhile, is at growing risk of recession, and any new energy shock brought on by geopolitical conflict (e.g. via Russia-Ukraine or Iran-Israel) would likely cause the euro to plummet towards parity (where one euro equals one dollar) or below.
Then, too, Japan is fighting a currency crisis (the yen is at multi-decade lows) because Japanese interest rates are too low relative to U.S. interest rates, which set the benchmark via the world reserve currency (the dollar) and the number one safe haven asset (U.S. Treasuries)... but the Bank of Japan (BOJ) is terrified of hiking rates too quickly lest Japan's fragile recovery is snuffed out like a candle.
Another question to ask is, "what would cause the Federal Reserve to panic?"
Right now the Fed is far from panic. In response to uncomfortable inflation data, they are making a transition from dovish to hawkish.
And with respect to being hawkish, Fed Chair Powell has a secret: He knows he can still hammer the economy into submission, if need be, by hiking rates to the point of causing a hard landing recession.
This is why we maintain (as we have said before) that the time to really turn bullish on inflation sensitive assets is after the U.S. economy has cracked... and when the Federal Reserve has been forced into panic mode as a result of either severe economic weakness (a clear hard landing unfolding) or some form of financial crisis or fiscal crisis.
In the absence of that, rising rates at the long end of the U.S. Treasury curve, coupled with a strengthening dollar, can just keep reinforcing each other in a relentless feedback loop... until something breaks.
Until next time,
Justice Clark Litle Chief Research Officer, TradeSmith
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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