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By: Rhona O'Connell, Head of Market Analysis
Triple whammy – Debt Ceiling, Budget proposal, CPI; a re-run of 2011?
In 2011, gold gained 43% in price. See section one below to find out why, and the possibility that it could happen again.
Three things have happened since the start of U.S. business hours yesterday (Wednesday 11th). that could potentially affect sentiment in the gold market.
1. The debt-ceiling impasse is now taking the headlines again with 46 Republican Senators signing a letter on 10th August saying that they will “not vote to increase the debt ceiling, whether that increase comes through a standalone bill, a continuing resolution, or any other vehicle”. The $.35Tn plan outlined above does not include any measure with respect to the debt ceiling. The Government is hoping to get the debt ceiling vote through on a budget reconciliation process, which requires just a simple majority; ordinarily a minimum number of 60 votes in the Senate is necessary to get such a bill through. This is what the Republicans are refusing to countenance so it looks as if the debt ceiling wrangling is, as has happened on more than one occasion before, going to be protracted.
It also means that there is a possibility (albeit very faint) that the Treasury could default. This has never happened before as a default is virtually unthinkable and in 2011, when the negotiations took a seemingly interminable amount of time, the term “kick the can down the road” was commonplace. This time, because there was nothing in the budget plan passed last night, the next chance to kick this particular can down the road must be taken by 30th September.
If the impasse lasts for a long period of time, then the markets are likely to suffer and this, too points to gold as a risk mitigation. When it happened in 2011, gold ran from $1,346 to $1,926; a gain of 43%.
Spot gold, January 2010 to date
Source: Bloomberg
2: The Senate has passed President Biden’s $3.5Tn budget proposal, with the 50-49 vote matching party lines, although it is not yet certain that it will be passed into law. At least two Democrat Senators went on record last night to the effect that the bill (no pun intended) for this social spending programme is too big, not least due to the potential inflationary impact. Many Republicans hold the same view. President Biden’s rebuttal was that voting against the plan would potentially scupper any reduction in “the cost of health care, housing, childcare, elder care and prescription drugs for American families”.
Meanwhile the bipartisan $550Bn infrastructure proposal has also been passed by the Senate, and some Democrats are threatening to withhold their support for the latter unless the former goes through. The House is to be recalled for a vote on the budget on 23rd August. The passage of this infrastructure bill is being hailed as a significant victory for the President – and voting it into law has been regarded by many members of Congress as contingent upon the larger plan being passed.. One key element here is that the infrastructure package garnered support from both sides of the House and has been a very long time coming – since way before the election of this President.
As far as gold is concerned, uncertainty is always good for the gold price as investors seek to mitigate risk; but also in this instance a key theme running through the opponents of this $3.5Tn proposal is the fear that it would fan the flames of inflation.
3. Yesterday’s CPI numbers were steady month-on-month at the headline level, at 5.4% year-on-year. The energy component remained strong and, judging from the performance of the oil price over the past 14 months, that element will remain strong for some months to come, probably to at least the end of the year. But this is a transitory factor.
WTI, January 2020 to date
Source: Bloomberg
So what else do we have? Probably the key is that the month-on-month increase in core inflation (excluding food and energy) rose by just 0.3% month-on-month, compared with 0.9%, 0.7% and 0.9% in April May and June respectively. Significantly growth in every component was lower than in June, with the biggest slowdown coming in used trucks, while transportation services were actually negative. Looking at the whole picture, but stripping out energy, the only component that grew at a faster rate than in June was food away from home, which has been increasing steadily since March as the lockdowns have eased and leisure/hospitality has opened up.
The point here is not gold’s role as an inflation hedge. We have discussed several times before that gold only really kicks in against inflation when inflation itself is a threat to the economy. At the moment it is acting more as a lubricant, which is a good thing. Of much more significance at present is what these numbers mean for the Fed’s accommodative policy.
Clearly this is only one number and Jay Powell wants a body of evidence in all areas before the FOMC makes any palpable changes to its existing policy. But these numbers do give some weight to the view that current inflationary forces are transitory, especially when we tie that in with what the bond market is telling us (see yesterday’s piece here). Some FOMC members are still advocating starting tapering before the end of the year, but that argument has been weakened slightly by these CPI figures. The downside risk to this is what happens with rentals over the next few months as they comprise over 30% of CPI and would be persistent rather than transitory; also the massive gain in productivity in July is likely itself to be transitory.
So we can expect tapering, that is for sure, but on balance it looks more likely to be later rather than sooner. We await Jay Powell’s presentation at Jackson Hole.
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