Category: US & Canada

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Inflation spooks Treasuries and stocks

Rising inflation expectations and robust economic data mean the Fed will likely pause rate cuts for several months. Stocks reacted negatively, but gold seemed unfazed.

The US economy shows slow but steady growth, with total weekly hours worked growing at an annual rate of 1.0% compared to real GDP at 2.5% in 2024.

Real GDP & Total Hours Worked

Heavy truck sales, a reliable leading indicator, fell sharply in December but rebounded to a robust 44.5K in January.

Heavy Truck Sales

Another reliable leading indicator is employment in cyclical sectors, which also shows robust growth. In a recession, manufacturing, construction, and transportation & warehousing typically shed far more jobs than the rest of the economy.Employment in Cyclical Sectors: Manufacturing, Construction, and Transport & Warehousing

ISM Survey

ISM business surveys show continued expansion in the services sector in January.

ISM Services PMI

It was joined by a manufacturing recovery above 50% after 26 months of contraction.

ISM Manufacturing PMI

Labor Market

The labor market added a modest 143K jobs in January.

Employment Growth

However, the unemployment rate fell to 4.0% from 4.2% in November, possibly aided by a surge in deportations.

Unemployment

Average weekly hours worked fell to 34.1 for the first time since the 2020 pandemic. This typically serves as an early warning of increased layoffs. Employers first cut back hours before shedding staff.

Average Weekly Hours

Lower weekly hours is contradicted by the JOLTS report, which showed job openings exceeding unemployment in December.

Job Openings

Average Hourly Earnings

A sharp increase in average hourly earnings, showing 4.1% growth for the 12 months to January, will likely cause concern at the Fed.

Average Hourly Earnings

December earnings growth surprised, at close to 0.5% for the month or 5.7% annualized.

Average Hourly Earnings - Monthly

University of Michigan Survey

Consumer sentiment dipped slightly in February, with the 3-month moving average declining to 71. Sentiment remains below levels during the 2020 pandemic.

University of Michigan: Consumer Sentiment

The current economic conditions index declined to 68.7 in February, but the 3-month MA is still rising.

University of Michigan: Current Economic Conditions

Expectations are also falling, with the 3-month MA declining to 70.

University of Michigan: Consumer Expectations

Financial markets were spooked by the sharp jump in expected price increases in the next 12 months, which reached 4.3% in February, with the 3-month MA at 3.5%.

University of Michigan: 1-Year Inflation Expectations

Five-year inflation expectations are also rising, with the 3-month MA climbing to 3.2% in February.

University of Michigan: 5-Year Inflation Expectations

Treasury Market

Ten-year Treasury yields rallied in response to the stronger inflation outlook, testing resistance at 4.5%. Recovery above the descending trendline would warn of another advance.

10-Year Treasury Yield

Stocks

The S&P 500 fell sharply in response to the prospect of higher interest rates. Breach of 5850 would signal a test of primary support at 5800.

S&P 500

Dollar & Gold

The Dollar rallied, testing resistance at 108 in response to higher interest rates. Breakout would offer a short-term target of 110.

Dollar Index

Gold is retracing to test support at $2,850 per ounce. Respect would signal a test of $3,000.

Spot Gold

Silver broke its new support level at $32 per ounce, warning of retracement to test $30.

Spot Silver

Conclusion

Strong growth in average hourly earnings and rising consumer inflation expectations will likely cause the Fed to pause rate cuts until the current uptrend reverses. That could take more than six months.

10-year Treasury yields are expected to resume their uptrend. Recovery above 4.5% would confirm.

Rising long-term yields are bearish for stocks, with the S&P 500 likely to test primary support at 5800.

The Dollar Index is also expected to resume its uptrend. Breakout above 108 would signal another test of resistance at 110.

Gold is expected to continue its uptrend, with a breakout above $2,900 per ounce signaling a test of $3,000 for the first time. Rising inflation expectations and increased bullion holdings by foreign central banks will likely maintain a shortage of physical gold.

Acknowledgments

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Weekly Market Snapshot

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The dial on the left indicates bull or bear market status, while the one on the right reflects stock market drawdown risk.

Bull/Bear Market

The Bull/Bear Market indicator rebounded to 60%, due to data revisions to heavy truck sales. Two of the five leading indicators now signal Risk-off:

Bull-Bear Market Indicator

Heavy truck sales were revised up to a seasonally adjusted 37,823 units in December, after an earlier report at 35,152 units. January sales jumped to a hot 44,499 units confirming that economic activity is not slowing.

Heavy Truck Sales (units)

This is the second time that a heavy trucks data revision has affected our model. We will investigate using a 3-month moving average to reduce the impact of revisions.

Stock Pricing

Stock pricing eased slightly to 97.75 from the 97.91 percentile two weeks ago. The extreme reading continues to warn that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

The Stock Pricing indicator compares stock prices to long-term sales, earnings, and economic output to gauge market risk. We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

Conclusion

We are close to a bear market, with the bull-bear indicator revised to 60%. Stock pricing remains extreme, increasing the risk of a significant drawdown, warning not to increase exposure to risk assets like growth stocks.

Acknowledgments

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Gold riding high as the Dollar weakens

A weakening Dollar has further boosted gold, lifting it above resistance at $2,800 per ounce. Treasury yields are also falling as anticipated inflation declines. However, volatility remains high, and we need to stay focused on the long-term trend.

Treasury Markets

Ten-year Treasury yields broke support at 4.5% with declining Trend index peaks indicating selling pressure. We expect a correction with a target of 4.2%.

10-Year Treasury Yield

The Dollar

The Dollar Index surprised, retreating below 108. Another test of support at 107 is likely, with declining Trend Index peaks indicating selling pressure.

Dollar Index

Gold and Silver

Gold soared to an intra-day high of $2,880 per ounce, with rising Trend Index troughs signaling strong buying pressure. The breakout offers a short-term target of $3,000. A retracement that respects new support at $2,800 would strengthen the signal.

Spot Gold

Silver broke resistance at $32 per ounce before retracing to test the new support level. Respect would confirm a target of $35.

Spot Silver

Conclusion

Donald Trump’s threat and quick reversal of tariffs on Canada and Mexico precipitated Dollar weakness in the past few sessions.

A deliberate strategy to weaken the Dollar would likely yield better results for the US than tariffs. Tariffs risk retaliation from trading partners and undermine domestic industry’s long-term competitiveness in export markets.

A public policy to weaken the Dollar would likely face bitter opposition from Wall Street, which has long profited from the Dollar as a global reserve currency. Behaving like a bull in a China shop, however, may achieve the same ends for Trump, while he can deny that it was ever his intention.

However, we should not trade hunches and need to base our strategy on what we can clearly see. The dollar index’s long-term trend remains upward.

Dollar Index

The Treasury market shows surprising strength, with the 10-year yield breaking support at 4.5%. Bond market reaction to Fed rate cuts last year drove long-term yields higher, but upward pressure has eased now that the Fed has paused. Fears of a rebound in inflation are fading, lowering the term premium.

The long-term view, however, shows a continued uptrend.

10-Year Treasury Yield

Lower Treasury yields and a weak Dollar are both bullish for gold, which has broken resistance at $2,800 per ounce and is likely to test $3,000 in the next few weeks.

Silver lags gold because of far larger industrial demand, which is not expected to expand at the same rate.

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Japanese inflation bullish for US stocks

Japanese inflation climbed to 3.6% for the 12 months to December 2024, a sharp increase from 2.9% in November.

Japanese Inflation Rate - Annual

Wages growth is even hotter, according to Jim Grant:

Wage growth is on the march in Japan, as nominal cash earnings jumped 4.8% in December from the prior year period, blowing past the 3.7% consensus to mark the hottest single reading since 1997. That striking data point further stokes an inflationary impulse which left nationwide CPI at a meaty 3.6% year-over-year clip in December.

Accordingly, a reluctant Bank of Japan has been forced into action, hiking overnight interest rates by one quarter percentage point to 0.5% late last month, its most restrictive rate stance since early 2008. However, EZ-money-minded Kazuhiro Masaki, director-general of the BoJ’s monetary affairs department, stuck to his rhetorical guns in an address to parliament this morning, declaring that “we must support economic activity with loose monetary policy.”

Not so fast, Goldman Sachs believes. Further tightening is in the offing as soon as July per predictions from senior Japan economist Tomohiro Ota, with benchmark borrowing costs poised to reach 1.5%, a level unseen for 30 years.

The Yen strengthened in recent weeks, with lower Trend Index peaks indicating buying pressure (selling pressure for the USD cross). Breach of support at 150 would signal another test of 140.

Japanese Yen

A stronger Yen is typically bullish for bonds, with the 10-year Treasury yield (gray) declining in synch with the Yen/Dollar exchange rate (blue).

10-Year Treasury Yield & Japanese Yen

A strong Yen is also typically bullish for stocks, with the S&P 500 (navy) rising when the Yen/Dollar exchange rate (blue) declines.

S&P 500 & Japanese Yen

Conclusion

The Bank of Japan is expected to hike the overnight rate by 100 basis points in 2025, to a level not seen in 30 years. Rate hikes are likely to significantly strengthen the Yen against the Dollar, with a medium-term target of 140.

A sharp fall in the exchange rate increases financial market volatility in the US as carry trades unwind. However, a strong Yen typically coincides with falling long-term US Treasury yields, which would be bullish for stocks.

Acknowledgments

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Threat of a US-China trade war boosts gold

Donald Trump’s reversal on tariffs on Canadian and Mexican imports caused a sharp rebound in the S&P 500. However, tariffs on Chinese imports remain in place and have elicited a response from the Middle Kingdom.

Stocks

The S&P 500 retraced to test resistance at 6000. Respect would confirm a correction.

S&P 500

Six of seven mega-cap technology stocks showed losses, with only Meta Platforms (META) recording an up-day.

Top 7 Technology Stocks

Financial Markets

Financial market conditions remain stimulative, with Moody’s Baa corporate bond spread narrowing to 1.45%, the lowest level since 1997. This indicates the ready availability of credit.

Moody's Baa Corporate Bond Spreads

Treasury Markets

Ten-year Treasury yields continue to test support at 4.5%. Respect will likely confirm an advance to test resistance at 5.0%.

10-Year Treasury Yield

US Economy

ISM Manufacturing PMI improved to 50.9%, the highest level in 27 months, indicating a recovery in the sector.

ISM Manufacturing PMI

New orders jumped to 55.1%, indicating expansion.

ISM Manufacturing New Orders

However, the Prices sub-index also increased, indicating inflationary pressures.

ISM Manufacturing Prices

Leading industry sectors also warn of a slowing economy. Airfreight and logistics (blue) plunged by more than 10% and would flag a recession ahead if joined by a decline in either containers and packaging (orange) or road and rail (green).

Leading Industry Sectors

China Tariffs

China has slapped tariffs on US imports in a swift response to Donald Trump’s duties on Chinese goods, renewing a trade war between the world’s top two economies as America’s President seeks to punish Beijing for not halting the flow of illicit drugs.

Mr Trump’s additional 10% tariff across all Chinese imports into the US came into effect at 12.01am Eastern Time on Tuesday (5.01am GMT).

Within minutes, China’s Finance Ministry said it would impose levies of 15% for US coal and Liquid Natural Gas and 10% for crude oil, farm equipment and some cars and trucks. The new tariffs on US exports will start on February 10, the ministry said.

China also said it was starting an anti-monopoly investigation in Alphabet Inc’s Google, while including both PVH Corp, the holding company for brands including Calvin Klein, and US biotechnology company Illumina on its “unreliable entities list”.

Separately, China’s Commerce Ministry and its Customs Administration said it is imposing export controls on tungsten, tellurium, ruthenium, molybdenum and ruthenium-related items to “safeguard national security interests”. China controls much of the world’s supply of such rare earths that are critical for the clean energy transition. (Evening Standard)

Dollar & Gold

The Dollar Index retreated from resistance at 110, but respect of support at 108 will likely confirm another test of 110. The threat of increased tariffs is expected to strengthen the Dollar and increase upward pressure on long-term interest rates as foreign central banks sell reserves to support their currencies.

Dollar Index

Gold broke resistance to set a new high at $2,816 per ounce. Expect retracement to test the new support level at $2,800, but respect will likely confirm our target of $3,000.

Spot Gold

Conclusion

Canada and Mexico are a sideshow, with China likely to be the primary target of US sanctions imposed by the Trump administration. China’s swift retaliation is expected to lead to escalation.

China is in a far weaker position because of its large trade surplus with the US. A trade war is expected to hurt Chinese manufacturing and raw material imports. However, the US will also likely suffer an economic slowdown as global trade shrinks.

We expect the Dollar to strengthen, driving up long-term Treasury yields, which would be bearish for stocks and bonds.

We also expect a trade war to boost demand for gold as central banks reduce their exposure to US Treasuries.

Acknowledgments

Posted on

Tariff Pause

MEXICO CITY/WASHINGTON/OTTAWA, Feb 3 (Reuters) – U.S. President Donald Trump suspended his threat of steep tariffs on Mexico and Canada on Monday, agreeing to a 30-day pause in return for concessions on border and crime enforcement with the two neighboring countries.

U.S. tariffs on China are still due to take effect within hours.

Both Canadian Prime Minister Justin Trudeau and Mexican President Claudia Sheinbaum said they had agreed to bolster border enforcement efforts in response to Trump’s demand to crack down on immigration and drug smuggling. That would pause 25% tariffs due to take effect on Tuesday for 30 days.

Mexico

Canada

Theatrics

The pause gives Canada and Mexico 30 days to reduce their exposure to the U.S. economy. Otherwise, the whole cycle of abuse begins again.

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Fed takes a pause

Fed Chair Jerome Powell announced that the FOMC has left the fed funds target range unchanged at 4.25% to 4.5%.

Powell described the labor market as “pretty stable and broadly in balance,” with a low hiring rate and an equally low quit rate.

Quit Rate

The key question for investors in the post-announcement news conference. Axios: “Was there any discussion on the timeline for ending the QT program?”
Powell responded that their indicators suggest that reserves are still abundant, and the Fed would continue with QT until that changes.

Commercial bank reserves at the Fed reached $3.33 trillion on January 22.

Commercial Bank Reserves at the Fed

However, the decline in bank reserves is expected to accelerate as the rundown in overnight reverse repo (RRP) liabilities nears an end. The reduction in RRP caused money market funds to invest more than $2 trillion in T-Bills over the past two years, effectively offsetting the withdrawal of liquidity via QT.

Fed Reverse Repo (RRP) Liabilities

Financial market conditions currently signal abundant liquidity, with the Chicago Fed Index falling to -0.65. However, that could reverse as the Fed persists with its rundown of securities on its balance sheet.

Chicago Fed National Financial Conditions Index

We will continue with weekly charts for the present as they help to keep daily volatility in perspective.

The 10-year Treasury yield (TNX) below has found support at 4.5%, and respect would signal an advance to 5.0%.

10-Year Treasury Yield

The S&P 500 is testing resistance at 6100. Selling pressure is secondary, and breakout will likely offer a target of 6400.

S&P 500

Dollar & Gold

The Dollar Index (DXY) found short-term support at 107. Recovery above 108 would indicate another test of 110. Broad imposition of tariffs would likely signal the continuation of the long-term uptrend.

Dollar Index

Gold is testing resistance at $2,800 per ounce after a bullish shallow correction. Breakout would offer a target of $3,000.

Spot Gold

Silver remains bearish, testing support at $30, with the trend direction uncertain until a breakout above $32.

Spot Silver

Conclusion

The Fed is likely to keep rate cuts to a minimum for as long as the labor market remains “in balance.”

Liquidity is likely to have a greater impact on financial markets, with an expected contraction in 2025, which is bearish for stocks and bonds.

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The long game: The Dollar, Gold and US Treasuries

In the short term, the Fed and US Treasury manipulate the Dollar and US Treasury yields in an attempt to stimulate the economy while avoiding inflation. Foreign central banks also attempt to manipulate the Dollar to gain a trade advantage, which impacts the Treasury market. However, in the long term, large secular trends lasting several decades will likely determine the direction of US financial markets and fuel a bull market for gold.

Short-term Outlook

Inflation has moderated, with CPI falling below 3.0%, allowing the Fed to cut interest rates. The fall in headline CPI (red, right-hand scale) was precipitated by a sharp decline in energy prices (orange, left-hand scale).

CPI & Energy CPI

However, inflation could rebound if geopolitical tensions restrict supply or demand grows due to an economic recovery in China and Europe or further expansion in the US.

The Fed has cut its interest rate target by 1.0% from its 2024 peak to stimulate economic activity.

Fed Funds Target Rate: Mid-point

Efforts to normalize monetary policy have reduced Fed holdings of Treasury and mortgage-backed securities by $2 trillion. This would typically contract liquidity, stressing financial markets.

Fed Holdings of Treasuries & Mortgage-backed Securities (MBS)

However, the Fed neutralized its QT operations by reducing overnight reverse repo (RRP) liabilities by nearly $2.3 trillion. Money market funds were encouraged to invest in the enormous flood of T-bills issued by Janet Yellen at the US Treasury instead of in reverse repo from the Fed. The simultaneous reduction in UST assets and RRP liabilities on the Fed’s balance sheet left financial market liquidity unscathed.

Fed Reverse Repo Operations

Long-term Treasury yields climbed despite the Fed reducing short-term rates, indicating bond market fears of an inflation rebound. However, a benign December reading for services CPI (below) triggered a retracement.

CPI & Services CPI

Respect of support at 4.5% will likely signal an advance to test resistance at 5.0% on the 10-year Treasury yield below.

10-Year Treasury Yield

The Dollar Index found support at 109 and is expected to re-test resistance at 110. The strong Dollar increases pressure on foreign central banks to sell off reserves to defend their currencies, driving up yields as foreign selling of Treasuries grows.

Dollar Index

Gold is trending upwards despite rising Treasury yields and the strong Dollar. Breakout above $2,800 per ounce would offer a medium-term target of $3,000.

Spot Gold

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The Long Game

The elephant in the room is US federal debt, which had grown to $35.5 trillion at the end of Q3 in 2024.

Federal Debt

Fiscal deficits are widening, with interest servicing costs recently overtaking defense spending in the budget.

CBO Projected Federal Deficit

Federal debt (red below) is growing faster than GDP (blue), warning that the fiscal position is unsustainable, especially as interest servicing costs widen the gap.

Federal Debt & GDP Growth

The ratio of federal debt to GDP grew to a precarious 113.3 percent at the end of Q3 2024 and is expected to accelerate higher.

Federal Debt to GDP Ratio

Long-term Treasury yields are rising as concerns grow over the unsustainability of debt and deep fiscal deficits fueling long-term inflation.

10-Year Treasury Yield

The strong Dollar further exacerbates the situation, increasing sales of US Treasuries, as mentioned earlier, when foreign central banks free up reserves to protect their currencies. The incoming Republican administration has committed to preserving the Dollar’s status as the global reserve currency. Maintaining reserve currency status is likely to entrench a strong Dollar. A Dollar index breakout above 110 will offer a target of the high at 120 from 2000, as shown on the quarterly chart below.

Dollar Index

As Luke Gromen points out, the Fed can cut interest rates to weaken the Dollar, but that would increase fears of inflation and, in turn, drive up Treasury yields. So, the rise in long-term Treasury yields is almost inevitable.

Gold respected support at $2,600 per ounce, as shown on the monthly chart below. The secular uptrend is fueled by four key concerns. First is the sustainability of US federal debt. Next is fear of rising inflation exacerbated by the on-shoring of critical supply chains and a decline in international trade. Third are geopolitical tensions, fostering rising demand for the safety of gold and an increased desire by non-aligned nations to break free from Dollar hegemony. Last is the collapsing Chinese real estate market, which no longer serves as the primary investment for private savings, leaving gold the most attractive alternative.

Spot Gold

Breakout above $2,800 would offer a long-term target of $3,600 per ounce.

Conclusion

Treasury yields are in a secular uptrend, with the bond bear market expected to last at least a decade. The primary driver is concern over the sustainability of US federal debt, which exceeds 110% of GDP, while deficits threaten to expand. Not far behind are fears of rising long-term inflation, fueled by expanding fiscal deficits while the economy is close to full employment, and increased protectionism driving up costs.

The Dollar is likely to remain strong, with the Index expected to reach 120, as long as the US remains committed to preserving the Dollar’s status as the global reserve currency.

Gold is riding a secular wave, fueled by concerns over the sustainability of US federal debt, fears of long-term inflation, rising geopolitical tensions, and collapse of the domestic real estate market as an attractive investment for private Chinese savings. We expect this to last for decades, perhaps even longer. Our target for gold is $3,600 per ounce by 2028.

The only feasible long-term path to reduce federal debt relative to GDP is for the Fed to suppress interest rates. This would allow GDP fueled by inflation to grow at a faster rate than fiscal debt and gradually reduce the ratio of debt to GDP to sustainable levels. The inevitable negative real interest rates would further boost demand for gold.

Acknowledgments

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Inflation dips?

The 10-year Treasury yield retreated after the release of December CPI data, with breach of the rising trendline signaling a correction to test support at 4.5%.

10-Year Treasury Yield

However, the monthly chart below shows the long-term uptrend is unchanged, with the 10-year yield expected to reach 5.0%. Breakout above resistance would warn of an advance to 6.0%.

10-Year Treasury Yield

CPI Inflation

Core CPI (ocher) dipped slightly to 3.2% for the twelve months to December, while headline CPI (red) increased to 2.9%, holding stubbornly above the Fed’s 2.0% target.

CPI & Core CPI - Annual

Monthly data shows a sharp spike in headline CPI in December, increasing at an annualized rate of 4.7%. Core CPI, however, slowed to 2.7% (annualized).

CPI & Core CPI - Monthly

Energy

The difference is energy costs, excluded from core CPI, which jumped 2.63% in December, warning of rising energy prices in 2025. The December increase equates to an annualized rate of more than 30%.

CPI Energy

Energy prices are a key vector for transmitting inflation. Prices rise steeply during a boom as expanding demand outstrips inelastic supply, and the opposite occurs during a recession when falling energy demand causes a surplus. Energy prices (orange below) rose ahead of headline CPI (red) in 2021 and fell ahead of its subsequent decline in 2022 – 23.

CPI & CPI Energy - Annual

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Services

CPI for services (excluding shelter) was a low 0.099% in December or 1.2% annualized. Services generally indicate more persistent inflation, so the Fed will likely treat this as a win.

CPI Services excluding Shelter Rents

Long-term Inflation Outlook

Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.

University of Michigan: 5-Year Inflation Expectations

We do not anticipate a significant hike in CPI in early 2025, but there are warning signs of a rebound.

Brent Crude

Brent crude has climbed to above $80 per barrel on fears that new sanctions on Russian shipping will impact supply. Retracement that respects support at $80 would confirm another advance.

Brent Crude

Stocks

Mega-cap technology stocks rebounded from yesterday’s fall, with the two most volatile Nvidia (NVDA) and Tesla (TSLA) showing gains.

Top 7 Technology Stocks

The S&P 500 index recovered above resistance at 5850, indicating another test of the high at 6100.

S&P 500

Large caps also enjoyed support, with the equal-weighted index ($IQX) testing resistance at 7200. Breakout would indicate another test of 7600.

S&P 500 Equal-Weighted Index

Growth stocks rebounded from their recent sell-off relative to defensive stocks. However, the Russell 1000 Large Cap Value ETF (IWD) has outperformed the Russell 1000 Large Cap Growth ETF (IWF) over the past month.

Russell 1000 Large Cap Value ETF (IWD) & Russell 1000 Large Cap Growth ETF (IWF)

Financial Markets

Bitcoin is again testing resistance at $100K. Reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds, but there are signs that financial conditions are easing. Breakout above $100K would confirm.

Bitcoin (BTC)

Expanding liquidity is partly attributable to a $350 billion fall in Fed overnight reverse repo operations in January after an equally sharp rise in December caused a contraction.

Fed Overnight Reverse Repo Liabilities

The Chicago Fed National Financial Conditions Index declined to -0.63 on January 10, suggesting similar financial easing to 2021.

Chicago Fed National Financial Conditions Index

Moody’s Baa corporate bond spread has also narrowed to 1.44%, the lowest since the 1990s, which indicates ready credit availability.

Moody's Baa Corporate Bond Spreads

Gold

Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.

Spot Gold

The monthly chart below shows the long-term view, where breakout above resistance at $2,800 (green) would offer a target of $3,600.

Spot Gold

Conclusion

Our three pillars supporting financial markets are 10-year Treasury yields, crude oil prices, and financial market liquidity.

Financial market liquidity is strong and supports demand for stocks and bonds with easy access to leverage.

Crude oil prices have been subdued since 2023, with strong production from non-OPEC+ producers (especially the US) and weak demand from China. However, geopolitical tensions now threaten supply, with Brent crude rising above $80 per barrel. The risk is that higher energy prices cause a resurgence of inflation and drive up long-term interest rates.

Inflation concerns over a tight labor market were temporarily allayed by December’s weak core CPI and services CPI growth. However, rising energy costs will likely increase input costs, causing a rebound in the months ahead. Market concerns over inflation are expected to grow as the incoming administration attempts to stimulate an economy already at close to capacity. The 10-year Treasury yield may briefly retrace to test support but is then likely to continue its long-term uptrend. Breakout above 5.0% would offer a target of 6.0%, which would be bearish for stocks and bonds.

We are underweight growth stocks trading at high earnings multiples and are avoiding financial instruments with a duration longer than two years.

Gold will likely benefit from a higher long-term inflation outlook and rising geopolitical tensions. We are overweight gold and defensive stocks trading at reasonable multiples relative to earnings.

Acknowledgments

Posted on

Inflation fears threaten higher interest rates

Markets are hesitant ahead of December CPI data due for release in a few hours.

Fearful of a resurgence in inflation, Treasury investors are driving up long-term interest rates, with the 10-year yield headed for a test of 5.0%.

10-Year Treasury Yield

Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.

University of Michigan: 5-Year Inflation Expectations

Producer prices are also rebounding, with services PPI recovering to 4.02% in December.

PPI Services

We do not anticipate a significant hike in CPI, but there are warning signs of a rebound.

Brent Crude

Brent crude climbed to $80 per barrel on the threat of new sanctions on Russian shipping impacting supply. Retracement that respects support at $76 would warn of another advance.

Brent Crude

Energy prices are a key vector for inflation. The chart below shows how energy CPI (orange) rose ahead of headline CPI (red) in 2021, and its fall in 2022 – 23 was instrumental in inflation’s subsequent decline.

Energy CPI & Headline CPI

Stocks

Mega-cap technology stocks are dragging the S&P 500 down, with former frontrunner Nvidia (NVDA) falling 7.2% over the past two months. Tesla (TSLA) has also shed almost half its December gains.

Top 7 Technology Stocks

The S&P 500 index is retracing to test resistance at 5850. Respect would warn of a further decline to 5700.

S&P 500

Large caps enjoy more support, with the equal-weighted index ($IQX) respecting key support at 7000.

S&P 500 Equal-Weighted Index

Rising long-term interest rates have set off a migration from high-multiple growth stocks to more defensive value sectors, with the Russell 1000 Large Cap Value ETF (IWD) outperforming the Russell 1000 Large Cap Growth ETF (IWF) in the past few weeks.

Russell 1000 Large Cap Value ETF (IWD) & Russell 1000 Large Cap Growth ETF (IWF)

Financial Markets

Bitcoin struggles to break resistance at $100K as financial market liquidity tightens. A reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds.

Bitcoin (BTC)

Gold

Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.

Spot Gold

The monthly chart below shows the long-term view, where breakout above $2,800 would offer a target of $3,600.

Spot Gold

Conclusion

Rising long-term Treasury yields reflect the growing risk of long-term inflation.

The outlook is bearish for growth stocks trading at high earnings multiples and financial instruments with a duration longer than two years.

We remain bullish on gold and defensive stocks.

Acknowledgments

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