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Inflation, exchange rates, and the economy shape the policy decisions of central banks; the attitudes and words of central bank officials also influence the actions of market traders.
Money makes the world go round and currency is a permanent commodity. The forex market is full of surprises and expectations.
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Early last week, gold price have soared as inflation indicators continued to rise and became more general. This, in turn, forces traders to price in more expectations of rate hikes , even if the central bank against raising rates. Despite higher treasury yields and a stronger dollar, gold remains popular as inflation-adjusted yields remain low. Gold may continue to gain support if policy makers continue to stick to a provisional route. In addition, the dot plot for next month's FOMC meeting is probably the biggest highlight of the rate hike expectations.
Last week, market participants may have been surprised by the October inflation rate released by the U.S. Department of Labor, as it was much higher than the market had expected. Nevertheless, the market has seen a sharp rise in prices this year, with energy and food costs, in particular, pushing the consumer price index jumping 0.9% from the previous month, well above the market forecast of 0.6%. More worryingly, The consumer price index surged 6.2% from a year ago in last month. This is the first time since November 1990 that Americans have seen inflation spiral out of control.
The Federal Reserve, as well as the current administration, continues to believe that the current inflation spike is temporary and will decline over time. Despite the Fed has acknowledged that current inflation is much higher than expected and will last much longer than originally anticipated. They have been emphasizing the fact that "Supply bottlenecks and labor shortages contributed to most of the inflationary pressure. " as a result of the economic recovery that has led to extremely pent-up demand. The Federal Reserve and the current administration have also emphasized that inflationary pressures will return to normal by mid-2022. However, many analysts, including myself, are convinced that the recent rise in inflationary pressures will last much longer than the Fed's forecast.
While the Federal Reserve assures that inflation is temporary, market expectations suggest otherwise. Global anxiety about inflation is mounting among businesses as the cost of raw materials rises, increasing their pressure to raise consumer prices. Despite the Fed's assurances, the 10-year U.S. Treasury yield broke through the key resistance level. Rising price pressures have accelerated inflows into inflation-protected exchange-traded funds this year. The close relationship between inflation and commodities suggests that there is more room for raw material prices to rise in the future.
In financial markets, gold prices hit a five-month record high last Wednesday, leading precious metals prices higher as data showed U.S. consumer prices surged last month, making gold more attractive as an inflation hedge.
The dollar's rally also looked quite strong throughout most of the trading day, which usually dampens demand for gold from holders of other currencies. However, the dollar eventually eased most of its gains as it touched its highest point in over a year.
Gold, as a safe haven, rose for a fifth straight day, also supported by a decline in real yields on U.S. Treasuries and overall safe-haven sentiment that pushed down major Wall Street indices.
The Commitment of Traders (COT) Reports
As inflationary pressures have increased, historically, there has been a strong correlation between inflation and commodity prices. For example, the commodity return index has a strong positive correlation with the U.S. Consumer Price Index. The regression model shows an r*square of 0.7 over the last 40 years. A positive reading of 1 implies that security prices are in step.
There was no new data from the CFTC this week, but SPDR statistics show no change in positions so far, as ETF reserves have not yet reflected any rally. This is common, as physical reserves are inert and take time to react to changes in market sentiment.
Recent research on gold's short-term and medium-term price targets has concluded that gold will trade as high as $1,835 by the end of 2021. While we agreed to think that it was reasonable for gold prices to be so high this year, we thought the time to achieve this goal was accelerating considerably when inflation for October was released last week. The latest research predicts that the gold price will test $1,900 per ounce by the first quarter of 2022.
Variables for Future Gold Prices
For the change in gold prices in 2022, we believe gold prices will be slightly below the record high in August 2020 at $2,088 per ounce. However, this study suggests that we could see gold prices as high as $2,170 per ounce. Our highest forecast would be $2,300 per ounce.
The anticipation in this study is whether inflationary pressures are really back in line with the Fed's 2% target. The Fed's target is based on the core PCE index, which was 4.4% in September. As the U.S. core PCE ignores rising food and energy costs, the market generally believes it is unrealistic to use the indicator in this inflationary environment. Energy and food costs are the biggest factors contributing to the CPI's recent inflation rate of 6.2%. Based on the CPI inflation index, we believe that near-term inflationary pressures will remain at record highs for most of 2022 is more realistic.
Since last year, the wave of COVID-19 has severely restricted the normal operation of Japan's economic activity. But recently, due to the national widespread vaccination and a significant decline in the number of infected people in Japan, its economic activity has gradually recovered. At present, however, the shortages in raw materials and spare parts in Japan is affected by global supply chain problems, which puts more pressure on its resumption of economic activities.
The Current Economic Situation
The BOJ's Forecasts for Economic Activity
Overall, Japan's economy has continued to pick up from the bottom hit in spring last year. However, the spread of COVID-19 in Southeast Asia has delayed the procurement of raw materials and spare parts, which has led to a slowdown in the domestic production and exports growth in Japan. At the same time, Japan's current concerns about the wave of COVID-19 have increased pressure on its recovery of domestic services consumption. For this, the BOJ cuted its economic growth forecast for this year by 0.4 percent point to 3.4 percent.
Officially, the Bank of Japan said that the recovery in the domestic economy remains respectable and that the future economic plural remains intact. In particular, the corporate sector, despite has been affected by supply-side constraints, the demand-side is still strong and profit margins continue to improve. The BOJ expects the overall economy to improve significantly in the first half of 2022 as the impact of COVID-19 and supply chain constrains is projected to wane.
Under the above circumstances, the BOJ believes that Japan's real GDP will generally recover to pre-pandemic level in 2019 in the first half of 2022, while slightly later than the recovery in the U.S. and Europe. Thereafter, as the effective control of the pandemic and the resumption of normal economic activity progresses, Japan's economy continue to follow a growth path, supported by relatively high growth overseas economies accommodative financial conditions.
In addition, the BOJ made it a point to outline its views on recovery in domestic services and resolution on supply chain constrains.
Services Consumption Expected to Recover
Impact of COVID-19 on Services Sector
This summer, affected by a dramatic increase in the number of infections dute to the spread of the highly contagious Delta variant, the public vigilance against COVID-19 heightened. As a result, food, drink and accommodation services became subdued by about 40 percent below the pre-pandemic level. Japan's vaccination rates now have steadily risen to more than 70 percent, exceeding the levels in Europe and the United States. As a marked decrease in the number of confirmed cases, restrictions on various activities have been gradually eased since last month.
In addition, the Bank of Japan believes that employee income in the corresponding sectors of economic activities has gradually turned to an increase with the current steady progress in vaccination nationally and the easing of control over a series of public services consumption places. As people's vigilant against COVID-19 wanes, a recovery trend in services consumption will become pronounced.
Supply Chain Constraints Eased, Semiconductor Became a New Breakthrough
Supply-Side Constraints (left is confirmed new cases of COVID-19 in Southeast Asia, right is world seminconductor demand)
At present, Japan is facing downward pressure on both production and exports, especially in the automotive-related sector, which is suffering from a shortage of spare parts. This summer, the rapid spread of the Delta variant in Southeast Asia caused the temporary shutdowns of a large number of plants, and delayed in the procurement of parts in the global automotive supply chain, particularly in the Japanese automotive industry. The BOJ believes that the COVID-19 outbreak in Southeast Asia has been under control since September, production activities have gradually resumed and bottlenecks are expected to be resolved within the next few months.
Today, the most prominent parts shortages problems in the global supply chain is the semiconductors, along with the trend of acceleration in digitalization such as the shift to 5G and electrification of vehicles, the demand for semiconductors has expanded considerably in global. This became even more evident after the global factories shutdown caused by the pandemic. The BOJ believes it will also be a key breakthrough and economic breaking point for Japanese manufacturers in the future.
Price Level and Outlook
Commodity Prices and Prices of Transactions among Businesses
International prices for a wide range of commodities, such as crude oil and natural gas, have been surging recently, reflecting a combination of factors including a sharp recovery in global demand and supply, and the crude oil production has continued to be reduced. The upward pressure on global commodity prices has increased significantly overall due to labour shortages and logistic stagnation, as has Japan, where domestic corporate commodity prices have risen for the first time since 1981.
Price Developments
However, Japan's CPI (all items excluding fresh food) remained at around 0 percent.
There are two main reasons for the official explanation: Japanese firms have sufficient supply capacity, and the firms' cautious price-setting stance.
Japanese firms have a long-term employment and have been able to hoard their employees even during the COVID-19 pandemic. This partly on the back of employment adjustment subsidies and various forms of financial support measures in society. This has enabled Japanese firms to maintain their capacity to increase supply rapidly in order to face risen demand following the resumption of economic activity.
When faced with supply constraints, Japanese firms rarely announce price rises. Instead, they tend to focus on long-term relationships with customers and seek for understanding regarding delivery delays to meet their demand as much as possible while keeping prices constant.
Officials answered on CPI trend that Japan's consumer prices have gradually increased in positive territory on the basis of the exclusion of temporary factors such as mobile phone communication charges and energy. Meanwhile, firms' and households' price inflation expectations have began to recover, largely to pre-pandemic level. In addition, wage growth has gradually increased, mainly for industries with labour shortage.
Outlook for Prices
In view of the above, the rate of change in the CPI is likely to show a positive trend of moderately expansion in the short term, after which the growth rate is projected to gradually increase to about 1 percent as the supply and demand gap is expected to turn positive around the middle of next year.
(All images are from official website documents of the BOJ)
Due to growing supply chain bottlenecks caused by Covid-19, the expansion of world economic activity has shown a clear weakness, and economic recovery dragged by the relaxation of covid controls in various countries halted. Economic growth still be a task of primary importance in European market under the shadow of the pandemic. Hence, what does the euro-zone economy head to at this point and what will it do to the euro?
Traumatized by pandemic and supply chain bottlenecks, world economy is developing unevenly, with the pace of recovery in developed countries significantly higher than in developing countries, while supply chain bottlenecks remain an urgent worldwide problem to be solved.
The global composite output Purchasing Managers’ Index (PMI) – excluding the euro area –confirmed that growth momentum moderated in the third quarter of 2021, although it remained well above its historical average. Specifically, industrial production momentum continued to soften in advanced economies in July. Growth momentum in emerging market economies remained softer than in advanced economies, especially in the manufacturing sector.
At the same time, new data from the World Trade Organization (WTO) point to a steady increase in commercial services trade in the second quarter, although it remains 20 percentage points below its pre-pandemic level. Most governments have eased covid restrictions, while later an uncertain growth on trade and a restrained economy occur, which may be blamed for the supply crisis and rising energy prices.
Benefit from the exit of covid controls by European governments and spurring by higher vaccination rates, the EU has seen a strong rebound on the service, such as tourism, as evidenced by a 2.1% of quarterly GDP growth in Q2 and a recovery trend in Q3. However, European GDP growth remains below pre-pandemic levels, when manufacturing production continues to be constrained by the shortage of materials, equipment, labour and rising transportation costs and energy prices.
According to the most recent monthly data from the European Central Bank, euro-area GDP continued to be strong in the third quarter but gradually trended downward from the fourth quarter. Industrial production fell by 1.6%. The more timely composite output Purchasing Managers’ Index (PMI) rose to 58.4 in Q3 of 2021, up from 56.8 in Q2, reflecting falling manufacturing output (to 58.6) and rising activity in services (to 58.4). However, in October the PMI declined further, reaching 54.3, suggesting Manufacturing supply bottlenecks intensified and stocks of purchases reached a record high level.
Eurostat's report released in September showed that annual HICP inflation in the euro area rose further to 3.4% in September, up from 3.0% in August, and well above the ECB's stated inflation target. The euro-area inflation is expected to rise further by the end of this year. The inflation spike is mainly affected by three factors: one, the reopening of the euro area economies so that the strong will to recover, demand is stronger than supply leading to higher commodity prices. Second, energy prices rose sharply, accounting for about half of the overall inflation in September. In particular, crude oil prices rose, with OPEC failing to meet its targets in August and September and supply weakening. Third, the base effect associated with the end of the German VAT cut is still pushing up inflation. Based on the combination of the above three factors, inflation in the euro area will remain high.
The unemployment rate in the euro area declined in August, still supported by job retention schemes. The rate stood at 7.5% in August, 0.1 percentage points lower than in July and around 0.1 percentage points higher than before the pandemic in February 2020. The number of workers in job retention schemes is declining and represented around 2% of the labour force in August. Employment increased by 0.7% in the second quarter of 2021 and total hours worked increased by 2.3% in the second quarter. However, total hours worked in the second quarter of 2021 remained below the level recorded in the fourth quarter of 2019. Similarly, labour force participation in the second quarter of 2021 was still lower than pre-crisis levels by around 1.4 million people. It suggests that the employment status in the euro area is still not optimistic and will hardly improve in the short term.
Overall, economic outlook for euro area has brightened over the past months but it is mainly relying on the government's easing of control over the epidemic. Nevertheless, the pandemic in the EU remains very serious, perhaps the short-term recovery of the economy is only the "Prague Spring" and it is not sustainable, coupled with the fact that supply chain bottlenecks have still not been effectively addressed. In the long run, it will inevitably continue to drag down European economy. Meanwhile, the euro presents a clear depreciated trend since the end of May; the support level below is weaker, and the overall is in a downward trend.
No fatal challenge but the road ahead is uncertain
Kishida has stressed that his top priorities were to bring the epidemic under complete control to eliminate public anxiety, to revive economic growth and alleviate the gap between the rich and the poor, including the creation of a self-reinforcing cycle of growth and economic distribution under his “new capitalism” economic policy shifting from the neoliberal policies left in place by his predecessors, Junichiro Koizumi.
Kishida said at a late-night news conference on Nov. 10 that the government's current priorities are the pandemic and the economy, promising to announce its overall strategy for dealing with the novel coronavirus pandemic On Nov. 12. A comprehensive package of economic measures, including how to handle social disparities in wealth, will be compiled on Nov. 19 and Kishida will seek to pass a supplementary budget to implement those measures before year-end.
According to a report by Reuter Tokyo, Kishida vowed to develop a pandemic rescue stimulus plan worth "tens of trillions of yen", which will provide cash payouts and coupons for the coronavirus-hit households, to be announced next week. But according to Kishida's previous public statements, the main source of funding for this plan is likely via the issuance of new Treasury bonds, which in turn will be detrimental to the Japanese government's fiscal position.
At the plenary session of the House of Representatives on the 10th, Hiroyuki Hosoda, the chairman of the largest intraparty faction of the LDP, the Seiwa political research council, was elected as one of the speakers of the House of Representatives. As a rule, the speaker will leave the party membership. For this reason, senior officials of the faction held a meeting to approve a proposal to make the former Prime Minister Shinzo Abe the next chairman.
In 2012, Abe was elected president of the LDP and then left the Seiwa political research council, and had not joined an intraparty bloc even after stepping down from his leadership post in September last year, but his influence within the faction cannot be ignored. According to Japanese media reports, Abe will return officially at the faction's general meeting on the 11th, when the faction will be commonly known as the Abe faction.
Previously, Kishida was elected president of the LDP in the September election and then became prime minister of Japan, relying mainly on the support of Abe and former Deputy Prime Minister and Minister of Finance Taro Aso and other party bigwigs, therefore, when it comes to the nomination of the top of the LDP and the cabinet, important positions were naturally taken up by Abe and Aso forces.
Currently, Kishida's control over the regime has been strengthened by the resignation of the LDP Secretary General, Akira Amari, who is close to Abe and Aso, and the appointment of the No. 2 figure in a faction headed by Kishida, Yoshimasa Hayashi, to the key cabinet post of foreign minister. However, the change of factional power within the LDP will still have an important impact on Kishida's regime, especially on the issue of how to implement the "new capitalism" policy.
According to Jiji Press, at a press conference on his inauguration of serving the Foreign Minister, Hayashi has decided to quit as the head of a cross-party parliamentary group promoting Japan-China friendship, "to avoid causing unnecessary misunderstanding."
The move is intended to allay fears among some hard-line members of the LDP that his position as foreign minister might lead to a weak stance toward China. It is worth noting that Yoshimasa Hayashi has always described himself as "knowledgeable about China" rather than “pandering to China”, indicating that he has been reserved about the optimism of future Sino-Japanese relations.
Meanwhile, it is important to note that Hayashi is well-connected in U.S. politics, and on Japan-U.S. relations, he advocates that both sides should further deepen the alliance and strengthen deterrence and response power. This is an indication that the Kishida administration's diplomatic framework remains the same stance as that of the Abe administration - Japan places more emphasis on a rules-based international order to safeguard its own national interests and values and hopes to exert traction on countries including China and the U.S. within this framework.
Therefore, it is still difficult for Japan to adjust its diplomacy towards China, and it will continue to actively cooperate with the United States for the US strategic deployment in the Asia-Pacific region. In particular, Hayashi’s speech on 11th about the historical legacy of human rights issues has shown a tense relation with countries in the Asia-Pacific region to a certain extent.
The data released from Labor Department showed that CPI rose for the 17th month in October, increased 6.2% on a year-over-year basis, the highest level in 31 years. Core inflation, stripping out food and energy, increased 4.6%, beating expectations of 4.3% and continuing to set a new record since the outbreak of Covid-19.
In the face surprising inflation data, the financial market also reacted strongly, the VIX jumped close to 20, the three major US stock indexes that kept hitting new highs fell sharply, the dollar index soared to nearly 100 bps overnight, the US treasury yields soared, and the 5-Year Breakeven Inflation Rate hit 3.1%, the highest since 2002. Crypto currency intraday hit an all-time high again, and gold jumped more than $40......All kinds of rare records burst out.
Dollar surged with gold
It is fair to say that the high inflation data has not only renewed doubts about the credibility of the theory that inflation to be transitory, but also sparked speculation that the Fed may raise interest rates sooner than expected. So what we have seen is an unusual phenomenon: gold rose almost in tandem with the dollar index, breaking the negative relationship between the two.
Dollar surged, if only on the basis of rate hike anticipation builds, but gold rally is counterintuitive. Gold has almost fallen lopsided and moved almost in the opposite direction of the dollar after the release of stronger than expected CPI data this year, as high inflation could lead to tighter monetary policy. But this time gold bears seem to have no resistance, there is no too much entanglement in disk surface, gold even rose above 1860. It is clear that high inflation has sparked fears and riots, and that gold is playing a key role in hedging against inflation.
In fact, since the Fed announced to start tapering its bound purchases in November, which should be a signal of tighter policy, but gold has not been affected by the announcement and has staged an unusually strong rally. Shows that the market has fully digested the tapering in the early days and is now completely indifferent to it. As for the continuity of inflation, the Fed can be described as obsessively confident. The Fed has repeatedly made it clear that it is still premature to start talking about rate increases, at least until June next year, so the expected impact of rate hikes on gold at least at this stage is also minimal.
How does inflation affect gold?
Gold surged this time which also easily broke through a key resistance at 1832 and occurred as the dollar was moving higher, has also led several investment institutions to raise their expectations for the future movement of gold.
Citi lifted its zero- to three-month gold price target by 11% to $1,900 an ounce. David Meger, director of metals trading at High Ridge Futures. He said, gold being the quintessential hedge against inflation, they believe inflation is the underlying positive environment that will foster the gold market rally in the weeks and months ahead. So what is the possible movement next for gold?
Gold itself has two main characteristics, it is both a typical hedge against inflation and very sensitive to interest rates, but when interest rate hike expectations rise and inflation spikes at the same time, many investors become confused.
Over the long term, the price of gold actually depends on the U.S. real interest rate, which is the yield of Treasury Inflation-Protected Security (TIPS), the difference between the treasury yields and the expected inflation rate for the same maturity. When the U.S. real interest rate rises, the price of gold falls; when the U.S. real interest rate falls, the price of gold rises.
Looking at just the last decade, gold has maintained a near-perfect inverse relationship with the yield of 10-year TIPS, with few exceptions.
In October, when CPI exceeded 6%, the U.S. bond yields collectively soared, as did the breakeven inflation rate, which represents inflation expectations, while the U.S. real interest rate, which represents the yield of TIPS, fell further. The 10-year TIPS yield fell as low as -1.243%, while the 30-year yield fell to -0.608%, both record lows.
Aside from the Fed's 0-0.25% nominal interest rate, real interest rates fell into negative, indicating that treasury yields, anchor of the global asset pricing, have run down inflation expectations and inflation is becoming more and more serious. As long as the Fed continues "printing money" in short-term, the U.S. real interest rates are likely to remain negative, and gold still has room to rise.
In terms of technical charts, gold broke through the key pressure level of 1832 after the early flag consolidation, and the next primary target are expected near 1900.
Recently, the news about the change of leadership of Fed set off a hot discussion in the whole market. Powell’s term as chairman of the Fed is set to expire in February 2022, and whether he will be reappointed as chairman of the Fed for the next four years is the focus of the market. Especially in the wake of the Fed’s Taper announcement, the market considering betting on future selections and is anxious for some indication of the policy bias.
Competitors
Current market expectations for mainstream Fed chair candidate center on current Fed Chairman Powell and Fed Governor Brainard. Powell is widely expected to win a second term, but Brainard is gaining support.
Powell
As his predecessor Yellen said, Powell has certainly done a good job, particularly in managing the transition without major missteps during a time of great challenges such as the covid-19. Powell, a Republican and former deputy Treasury secretary, joined the Fed board of Governors in May 2012 and has been nominated as chairman of the Fed since Trump took office. Powell is a centrist in monetary policy stance and supports easing financial regulation. Judging from his previous speeches and policy stance, although he had a "hawkish" tendency in monetary policy in the past, he paid more attention to balance and further strengthened the "expectation management" means of the Federal Reserve.
The Fed's monetary policy stance is expected to be more balanced if Powell is reappointed, but that is one of the biggest obstacles to his reappointment. Throughout history, the previous U.S. governments prefer to use relatively loose policies to stimulate and guarantee the growth momentum of the economy and the prosperity of the financial market in order to achieve political achievements. Powell raised interest rates four times in 2018, causing the stock market to tumble, which make the ruling Democrats worried, because they don't want any more fallout in next year's midterm elections.
Brainard
Another candidate, Fed Governor Brainard, a Democrat, was nominated as a member of the Fed board by Obama in 2014. Brainard is also a former deputy Treasury secretary whose monetary policy stance is seen as more dovish than Powell's and more in line with Democratic Party’s needs in the midterm elections. After Brainard was summoned by the White House, there was even more obvious turmoil in the market, with both short and long term treasury yields falling. Markets are beginning to anticipate whether brainard, if nominated, will favor a slower Taper process and a later tapering point.
Moreover, for the Fed's two main policy goals, Brainard prioritized full employment over inflation and was more tolerant of higher inflation. In a Speech in September, She said full employment should be measured not by aggregate measures but by the welfare and job market status of "marginalized" groups like people of color. In terms of financial stability, Brainard supports the development of digital currency in the United States, but does not support those virtual currencies with high volatility, inadequate supervision and severe risks. She strongly advocates the rectification of financial regulation, including the recent stock market turmoil caused by members of the Federal Reserve. On climate change, Brainard believes that the Fed should establish a climate monitoring and analysis model, and timely assess and predict the risk impact of climate change.
Brainard's track record on jobs, financial stability is also consistent with the Democratic Party, which will be an advantage in her chances of getting the Fed nomination.
Easing will continue
According to the latest odds on Predictit, a U.S. political betting website, Powell's chances remain high, even as Brainard's support continues to rise.
However, considering the overall easing environment of the Fed, many industry analysts believe that whoever wins, the basic framework of monetary policy will not change sharply, next June or so will finish the purchase.
Michael Feroli, chief U.S. Economist at J.P. Morgan, said there are many institutional factors that influence the Fed's decisions and provide continuity, including the role of regional banks and the influence of the Fed's staff. With Brainard seen as more dovish, the market could expect inflation expectations to rise further, but the renewed recovery in treasury yields also reflects affirmation of the continuity of Fed policymaking.
In short, there's no need to read too much into a Fed reshuffle or expect a dramatic change in policy, as the Fed does not want to see financial market turmoil.
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