What A Victory Over Inflation Looks Like To The Federal Reserve The Wary Bond Market

In its last statement and discussion on monetary policy, the Federal Reserve essentially announced its official victory over inflation. The Fed cut its interest rate by 50 basis points to 4-3/4 to 5% as part of a “recalibration” of policy from an era of high inflation and low employment to “where we are now and where we expect to be.” Where the Fed is now: a bottoming in the unemployment rate and an eager desire to prevent unemployment from spiraling higher unabated. Where the Fed expects to be: a world where GDP growth is solid at 2.0%, unemployment topped out at 4.4%, and inflation conveniently sticking the landing at the 2.0% target. The Summary of Economic Projections (SEP) shows a steady decline in the PCE and core PCE (Personal Consumption Expenditures) inflation, the Fed’s preferred measures of inflation. These graphs show a clear victory over inflation. Still, the 70% confidence interval remains wide over a range from close to 0% to 4%.  Gold DisagreesGold disagrees with the Fed’s inflation victory. Gold bugs are likely staring at the top end of the PCE confidence range (or even higher!). Gold is the most interesting contradictory signal for the Fed’s victory because it has easily outperformed the S&P 500 (SPY) this year. The SPDR Gold Trust (GLD) is up 26.7% year-to-date; this performance well outpaces the S&P 500’s 19.6% gain for the year. Gold can of course gain favor for a variety of reasons, but as long as rates are trending downward, I expect gold to continue higher. Notably, GLD bounced back sharply after its initial post-Fed fade and closed last week at a fresh all-time high. The Wary Bond MarketThe bond market looks a little wary about the Fed’s presumed victory. The iShares 20+ Year Treasury Bond ETF (TLT), which goes up when long-term interest rates go down, rallied into the Fed’s announcement on monetary policy. However, TLT gapped down ahead of the news and closed lower. TLT continued lower the rest of the week. It is possible the bond market got ahead of itself in anticipating economic weakness and/or lower inflation. Either way, I am looking at the technicals of TLT and see the confirmation of a (horizontal) presumed trading range. This trading range is working against the steep uptrend in the 20-day moving average (the dotted line in the chart below) and the 50-day moving average (the red line in the chart below). Thus, some kind of trend change or resolution is likely on the way in coming weeks. The outcome may sway my interpretation of the Fed’s inflation victory.  Bowman DisagreesBoth gold and the bond market could even take cues from the one dissenting voice on the Fed. On Friday, Governor Michelle W. Bowman explained why she only wanted a 25 basis point cut: “We have not yet achieved our inflation goal.” In particular, Bowman worries the 50 basis point cut “could be interpreted as a premature declaration of victory on our price stability mandate.” Bowman is not ready to declare victory.The next Fed meeting is not until November. There is a lot of time ahead for Fedspeak to lean against any excessive victory celebrations in the financial markets. I will keep an interested eye on the market’s reaction to sobering words of caution and restraint. The U.S. Dollar Hangs in the BalanceThe Fed’s implied victory over inflation is also the U.S. dollar’s loss. The Fed is a bit late in lowering interest rates relative to several of its peers. The European Central Bank (ECB), the Bank of England (BoE), and the Bank of Canada (BoC) each dared to lower rates ahead of the Fed’s move. Yet, currency markets stayed keenly focused on coming rate cuts from the Fed such that the U.S. dollar weakened against each of the related currencies even as other banks fell one-by-one.The British pound, Invesco CurrencyShares® British Pound Sterling Trust (FXB), benefited the most from dollar weakness of the currencies that are in the middle of rate cut cycles. Last week, FXB broke out to a fresh 31-month high. The weekly chart below shows FXB has room to recover back to its highs from 2021. Such a run is in the cards if Fed rate cut expectations continue to point lower. I want to get more bullish on the Canadian dollar, but Invesco CurrencyShares® British Pound Sterling Trust (FXC) barely shows signs of life. FXC is scraping along a bottom that has served as support since the lows of 2022. If FXC hurdles over the previous weekly high, I will get more constructive. In the meantime, it seems the Canadian dollar is captured by a fate similar to the U.S. dollar (DXY).  The Victory TradeSo far, the Fed’s victory over inflation looks like victory for gold and the British pound. The story from the stock market is mixed. While the S&P 500 is back to an all-time high, the NASDAQ remains below a bearish topping pattern. Small caps are languishing. I do not expect the story to get clearer during October given its reputation as one of the stock market’s most dangerous months. Thus I am (short-term) neutral on the stock market as a whole while I remain (perma) bullish on gold. Gold is my inflation victory trade.Be careful out there!More By This Author:An Exit From The 20% Rule For Buying EWZ (Brazil ETF)
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