As the Fed tightens monetary policy, fears of overdoing it are rising. However, the US central bank is far from overtightening. It increases the odds of stagflation and a bullish time for gold. As central banks all over the world are tightening their monetary policies, more and more analysts, including Paul Krugman, are afraid that Powell and his colleagues are hiking interest rates too aggressively, risking going too far. They believe that inflation will soon decline, so the Fed is braking too hard. Well, as always, there is some truth in these opinions. The inflation rate is likely to decrease as the growth in the money supply decelerates and even declines below the pre-pandemic rates (see the chart below). And monetary policy operates with a long lag, which means that the effects of the hawkish Fed’s actions haven’t been fully felt by the economy. Hence, the central bankers could easily overdo. After all, they are so incompetent that overreacting to inflation after a long period of underreactin wouldn’t be surprising at all. However, even my students are aware of lags in monetary policy, so there is a chance that someone from the army of PhDs working for the Fed has heard about them and taken them into account. But more seriously, although the pace of money supply growth has normalized, there is still an excess of money supply relative to output. As the chart below shows, since the global financial crisis, the increase in M2 money supply has been outpacing real GDP growth, reaching a peak during the pandemic. This growth differential hasn’t disappeared or turned negative yet, so with too many people chasing too few goods, inflation won’t go away very soon. You see, the current monetary policy is hardly a tight one. According to the Taylor rule, the key tool used by the central banks, the Fed should set the federal funds rate at least at 6.7% (see the chart below) – just to have a neutral stance! As the next chart shows, the real federal funds rate – understood as the federal funds effective rate minus the CPI annual rate – is still deeply negative. I’m not saying that inflation won’t disappear without the real federal funds rate being positive. After all, what’s fundamental for inflation is what’s happening with the money supply. However, positive real funds rates are high enough to slow nominal growth and reduce demand in excess of supply. The point is that it could be difficult to re-anchor inflation expectations without positive interest rates. Inflation expectations seem to have already peaked, but they remain historically high (see the chart below). As a reminder, what Paul Volcker did was take a huge hike in the federal funds rate to bring rates into positive territory and restore confidence in the Fed, pushing inflation expectations down. He raised the federal funds rate to 19% at the end of 1980. The real rate surged from -4.8% to 7.3% and then to the record 9.4%. Compare it with the current -5.7 (as of the end of October). We are not even close. What does it all mean for the gold market? Well, the truth is that the Fed is still conducting too easy, not too tight, monetary policy. The lending conditions have tightened, but this is because the financial sector has been cautious and forward-looking, not because the US central bank has become restrictive. We’re moving into this territory, but very slowly. It implies that a recession is coming just when the real federal funds rate is still deeply negative and the chorus of voices calling for a softening of the Fed’s stance gets louder and louder. For me, this is a recipe for stagflation rather than a successful disinflation. So far, the Fed has kept a stony, hawkish face, but when the economic situation deteriorates, I bet it will blink and won’t try to fight with inflation at all costs. Have you seen how quickly the Bank of England intervened during the recent market turmoil? Actually, stagflation is certain, in the sense that the next recession will be accompanied by higher inflation than the last few ones. The question is how serious it will be! That’s excellent news for the gold bulls, as stagflation is what gold likes best. This is because during stagflation, we have both economic stagnation and high inflation. When attacked by two enemies at the same time, most assets become vulnerable, and gold tends to outperform them. This is not surprising, as during stagflation there is a huge amount of economic uncertainty, confidence in the central bank is low, and real interest rates are on the decline, with some of them falling into negative territory. In other words, stagflation makes gold’s fundamental factors bullish. Want free follow-ups to the above article and details...

We have just seen the latest US inflation update in the form of the Consumer Price Index (CPI). The consensus expectation was for an increase of 7.9% year-on-year for Headline CPI. To everyone’s astonishment it came in lower at +7.7%. Core CPI, which excludes food and energy, also came in below expectations at +6.3% year-on-year, against a forecast of +6.6%. In addition, the month-on-month data showed signs of slowing, which was a relief given recent gains. This was exceptionally good news for investors as inflation, with just one exception this summer, has come in above expectations since the beginning of this year. Now it looks as if we can confirm that Headline CPI peaked, for this cycle, back in July at 9.1%. Bear in mind, the US Federal Reserve was very late in its response to surging inflation, raising rates by just 25 basis points in March this year. At that time inflation was running at 7.9%, up from 1.7% 12 twelve months previously. Since then, the Fed has raised rates by an additional 350 basis points, taking the upper range of its key Fed Funds rate to 4.0%, its highest level since December 2007. In addition, the futures market assigned a 50% chance of another 75-basis point hike this December, although that dropped to less than 20% following the latest inflation data. Risk on The market reaction was swift and dramatic. Stock indices flew higher. The S&P 500 added 100 points within the first minute of the release. There were also big gains for precious metals and government bonds while the US dollar dropped sharply. Many traders thought this reaction was overdone. But US stock indices built on their early advances and pushed higher over the next couple of hours. The big questions are: can we be confident that we’ve seen inflation peak, and how will the Federal Reserve react? Comparisons There’s little doubt that the year-on-year comparisons should flatter the data in terms of inflation growth. Headline inflation was 6.2% in November last year, rising to 7.9% in March before peaking in August. That means we should expect the year-on-year numbers to fall. Therefore, the month-on-month data should be the focus going forward. The Federal Reserve’s response should be interesting. The better-than-expected CPI data came just one week after the US central bank raised rates by 75 basis points for the fourth meeting in succession. In addition, Fed Chair Jerome Powell was notably hawkish during his subsequent press conference, dismissing suggestions of a pivot away from tightening monetary policy, and stating that existing predictions over the ‘terminal’ rate for Fed Funds were too low. Following this latest update, he won’t want to switch suddenly into reverse gear, but it’s likely that other Fed members will start to sound more dovish, particularly if unemployment starts to rise. Fortunately, the Fed’s monetary policy statement included some dovish comments. The FOMC (Federal Open Market Committee) said it would consider the cumulative effects of rate hikes. Given that rates have now risen to 4.0% from under 0.25% in just 8 months, that implied that smaller rate hikes, or even a pause, could now be expected. This view was reinforced by the FOMC stating that rate hikes act with a lag, and that they would be taking economic and financial developments into account. Again, with most market participants expecting an economic slowdown, and with unemployment near record pre-pandemic lows, it seems reasonable to expect weaker economic data in the future, giving the Fed reason to temper their aggressive monetary tightening. Many will now be wondering if this will provide a tailwind for equities, helping them to make back some of their losses going into year-end. 

Today is Veteran’s Day – and I (we) salute all of our men and women who have served this great country. As many of you know – my wife and I are very involved with the Headstrong Project – A national-facing mental health treatment practice of choice for our nation’s military, veterans and associated family members.  Operating as a non- profit we offer stigma free, bureaucracy free and cost free evidenced based, trauma focused treatment.  Currently we are treating more than 1500 veterans/month in over 44 states across the nation. Now – try the Italian Wedding Soup for a Thanksgiving first course. Yesterday I said that it was going to be all about the economic data….(now that we have the election behind us) and that data point was going to be the latest CPI report……there was speculation that it was going to come in with a 7 handle (I was in the 8 handle camp)…and that if it did, then we would see markets rally. We would see some analysts and members of the administration tell us how great of a job they are doing….that the Inflation Reduction Act was working!  How great is that?  Well, the CPI did surprise and the m/m increase was only 0.4% (vs. the expected 0.6%) but was the same as last month and the y/y number came in at 7.7% (vs. the expected 7.9%) and was down from 8.2% last month…..next up was the avg hourly earnings y/y and average weekly earnings y/y – those reports showed earnings declining by 2.8% and 3.7% respectively…..and you would say – Hey, wait a minute….earnings are declining – how could that be good?  - and the answer is:  They are declining at a SLOWER rate. Let’s just be clear – it was the used autos component of the CPI that fell, while everything else was UP…Energy up, food up, housing up, utilities up – so yes, the overall index fell, but when you pull back the sheets – you realize some of the more relevant components were anything but weaker….but if you focus on the headline number – what you saw was a decline…..Just sayin’. And then you had GS CEO Davey Solomon taking the stage singing the praises of the FED – saying that the tightening policy that they have engaged in, is beginning to work and prices are coming down…..Exactly what I said they would say – and the FED was sure to have Davey deliver that message…..GS is one of the banks that the FED uses to ‘tell the story’…..and the algo’s and trader types went berserk…..stocks traded higher like there was no tomorrow….in line sell orders suddenly disappearing – leaving the order books ‘empty’ on the way up…..forcing buyers to ‘pay thru the nose’ for the opportunity to buy stocks….remember – those buyers were all sellers only last week…. or maybe it was all of those short sellers that were betting on a higher CPI read that would have sent stocks lower – In any event – it was what it was, and markets were on FIRE.    As you might expect – it was the most beaten up indexes that performed the best and it was the most beaten up sectors that performed the best….by the end of the day - we saw the Dow gain 1200 pts or 3.7%, the S&P added 207 pts or 5.5%, the Nasdaq rocketed higher by 760 pts or 7.35%, the Russell added 107 pts or 6.11% and the Transports surged by 750 pts or 5.5%. Sector performance saw Tech – XLK rise by 8.8% (recall it was down more than 30% ytd) leaving it down 24% as of last night, Consumer Discretionary – XLY added 7.3% (it was down more than 37% ytd) leaving it now down only 30.6%, Real Estate – XLRE added 7.6% (it was down 32% ytd) and is now down only 25%, Communications – XLC +6% (it was lower by 42% ytd) and is now down 37%, Basic Materials – XLB added 5.5%, Financials – XLF +5%, Utilities – XLU and industrials – XLI added 4.7% and 4.2% respectively.  Consumer Staples – XLP, Energy – XLE and Healthcare – XLV all adding just over 2%. Disruptive Tech – ARKK added 14% (it was down over 74% ytd) and is now down only 60%!  Semiconductors – SMH  or SOXX – which have also been smashed this year – gained 10+% - still leaving those sectors down 30% ytd…..The value trade – SPYV added 3.8%, leaving it down only 6% ytd while the growth trade – SPYG added 7.4% leaving it lower by 26% ytd.  And the triple levered S&P long – SPXL gained a whopping 16% in 6 hours.   Treasuries prices rose sending yields plunging….the 2 yr. ended the day yielding...

United States: October prices give Fed ability to slow pace of rate hikes Relief in October inflation gives the FOMC the ability to slow the pace of rate hikes ahead. But make no mistake, the Fed's job of taming inflation remains far from over. We still expect it to raise the federal funds rate 50 bps at its next policy meeting in December, and now look for the policy rate to reach a peak of 5.25% by March, 25 bps more than we previously forecast, due to near-term resilience in spending and labor market strength. Next week: Retail Sales (Wed), Industrial Prod. (Wed), Housing Starts/Existing Home Sales (Thu/Fri). International: Mixed inflation trends from Latin America This week saw some mixed inflation trends from Latin America. Mexico's October CPI slowed to 8.41% year-over-year and energy prices slowed along with fruit and vegetables prices. However, the core CPI quickened further, and as a result, we fully expect the Bank of Mexico to raise its policy rate by 75 bps points this week. In Brazil, October inflation slowed further to 6.36% year-over-year, with lower taxes and gasoline prices as key drivers of the deceleration in recent months. Next week: Japan GDP (Tue), China Retail Sales & Industrial Output (Tue), U.K. CPI (Wed). Credit market insights: Consumer credit growth steadies as banks tighten lending standards Total consumer credit growth moderated in September, increasing by $25 billion in a step down from August's $30 billion gain. The Fed's quarterly Senior Loan Officer Opinion Survey, which generally covers the third quarter, found that banks have tightened their lending standards over the quarter and demand for most business and consumer loan types weakened. Topic of the week: Election day 2022 Election Day has come and gone in the United States, and although not every race has been determined, the broad contours of the election outcome have emerged. The most probable outcome appears to be a divided government, with Republicans controlling at least one chamber of Congress and the White House still safely in Democrats' hands. Read the full report here

The EURUSD driving average is located at 1.0805. Recall past writings. The target on a break of the 5 year average at 1.1400's was 1.0800 but EUR/USD decided to travel an additional 800 pips to 0.9500 bottoms. DXY 95 break at the 5 year average targeted 103.00's and decided to travel an additional 1100 pips to 114.00's. The EUR/USD drop to 0.9500's and DXY rise to 114.00's was unaccounted by 5 and 50 year averages or 600 monthly averages. Where was the true average? 60, 80 year monthly averages. In the life of trading and markets, we may never see again a market price so over and undervalued to trade at 50 year averages, especially from normal currencies such as EUR/USD and DXY. Only cross pairs and JPY contains ability to trade to such extraordinary depths yet remains rare. For the first time since March 22 when EUR/USD broke below 1.0800, EURUSD at 1.0223 normalized to account for a respectable average but only for the short term. Longer term, EUR/USD remains deeply oversold from target averages at 1.1100's, 1.1300's and 1.1600's. Next targets longer term are found at 1.0592, 1.0798 and 1.0967 upon a break at 1.0805. Not only is EUR/USD oversold but its price remains extrardinarily low. Short term, next targets are located at 1.0375,  1.0417 and  1.0592. Massive supports from rising averages are located at 1.0044, 1.0004 and many averages at 0.9900's. Higher EUR/USD faces the challenge of seasonality when EUR/USD begins its 6 month drop from December/ January to May/June while DXY and USD/JPY begins its 6 month rise for the same period December/ January to May /June. EUR/USD trades its lowest lows for the year in January. Next week Main drivers this week  as well as next week are USD and non USD currencies. Cross pairs follow. Best trades are EURUSD and GBPUSD then USDJPY and USDCAD. EURUSD trades overbought and due for a correction to 1.0168 and 1.0127 easily. DXY faces massive hurdles at 109.25, 110.20 then 111.00's and 112.00's. DXY from 107.00's and 5 and 50 year averages at 95.00's and 96.00's reveals DXY and USD currencies contain a long long way to drop. Next target for next week is 106.26. USDJPY break below current 142.64 was not only extrardinarily but this average held for the past year. We're long for next week to target 140.00's and 141.00's. USDCAD as written last week held at 1.3600's. From last week, 1.3418 broke and traded to 1.3284 lows. Break of 1.3380 targets higher for USDCAD. GBPUSD target at 1.1887 achieved 1.1775. Next week targets high 1.1600 as GBP/USD big break is located low 1.1600's to trade much lower. AUDUSD trades comfortably above 0.6599 and only a break at 0.6647 challenges 0.6599. Short for next week remain the overall strategy however a higher AUD would serve a better short trade for maximum profits. Same for NZD. GBP/AUD drives EUR/AUD at GBP/AUD 1.7589. EUR/AUD holds comfortably above 1.5236. Divergence between GBP/AUD and EUR/AUD builds and both may remain last on the trade rank list. GBP/JPY must clear above 165.27 to travel higher and allow all JPY cross pairs to follow. Last week's post, break 165.72 targets 164.00. GBP/JPY traded to low 163.00's. Overall next week is a range trade week. 

The central bank 'pivot' narrative got a boost from US CPI inflation surprising on the downside, falling back to 7.7% in October amid easing core inflation pressures. Terminal rate expectations declined and markets are now pricing only a 50bp Fed hike in December, challenging our call of a 75bp increase. Equity markets rallied on the prospect of less Fed tightening and the roller-coaster moves in yields continued, with spread tightening also seen in European rates. Geopolitical headlines of Russia withdrawing from the city of Kherson added to the volatility, as did comments from a range of ECB members suggesting that the recession view is gaining ground, although in contrast to the Fed, with no slackening of the hiking pace yet in sight. The rally in Chinese equities got a boost from an easing of quarantine rules for travellers, but new infections have climbed higher especially in the manufacturing hub of Guangzhou. Commodity prices, including oil, rose more than 1% on the back of broad USD weakening. We remain sceptical that a turnaround in the strict zero-Covid stance is coming anytime soon, and continue to think EUR/USD will decline back below parity despite the most recent uptick. As votes in the US midterm elections continue to be counted, the Republicans look likely to narrowly win the House of Representatives, but the anticipated 'Red Wave' did not materialise. Control of the Senate might not be known for weeks, as the race in Georgia goes to a December run-off. Overall, the market reaction was muted as little changes to fiscal policies are expected to result from the political gridlock, although we keep an eye on potential changes to US support for Ukraine and the upcoming debt ceiling discussions. The EU Commission published a first proposal for overhauling the EU's fiscal rules, which would allow countries to agree more realistic debt-reduction paths with Brussels, while creating extra space for public investment. Enforcement would be tightened, with a stricter regime for countries that face 'substantial' public debt challenges, but an agreement before mid-2023 seems unlikely. A busy week awaits on the geopolitical front, creating the backdrop for volatile markets. On Tuesday Indonesia will host the first G20 leaders' meeting after Russia's invasion of Ukraine. It has been confirmed that Russian President Putin will not attend in person, though he is planning a virtual participation in one of the meetings, in an encouraging sign that some level of dialogue between Western and Russian leaders continues. President Xi and Biden are also set to meet for their first face-to face meeting. Securing 'guardrails' on the Taiwan issue could be the most important topic, while we also look out for comments from Xi about his opposition to using nuclear weapons. In China we have a policy rate decision and a cut cannot be ruled out, as a range of 'hard data' will probably confirm that Covid uncertainty continues to dampen demand. In the UK, we look forward to the Chancellor's Autumn Statement on Thursday, where PM Sunak's government will spell out its fiscal plans. It is widely expected to include tax increases across the board to fill up the hole of approximately GBP 50bn in the UK's public finances, while October inflation numbers could take another big jump up. In the US, retail sales for October will reveal how well consumer spending is holding up amid high inflation. Download The Full Weekly Focus