(Kitco News) Inflation is one of the biggest risks that could derail economic recovery this year, especially if central banks get the tightening wrong, according to analysts.
Surging price pressures are being felt all across the globe. In the U.S., inflation ran at the hottest pace since 1982 in December, rising 7% over the past 12 months. Inflation in the eurozone reached a new record high of 5% annually in December.
In the U.K., inflation hit 10-year highs, with the consumer price index (CPI) up 5.1% in the 12 months to November. Spain’s price pressures climbed to nearly three decades highs, with the annual inflation up 6.7% in December. In Italy, the cost of living rose to the highest level in more than a decade in December, with the CPI advancing 4.2% compared to December 2020.
However, there are signs that global inflation might be close to peaking. For example, in China, price pressures moderated in December, opening the door for the central bank to continue to provide stimulus. The consumer price index was up 1.5% in December versus 2.3% in November. China’s producer price index also cooled, rising 10.3% annually, down from November’s 12.9%.
In the U.S. producer price index also decelerated, pointing to a cooling in inflation. The PPI measure was up 0.2% in December following November’s rise of 0.8%. The data was weaker than expected, with economists forecasting an increase of 0.4%. More specifically, food and energy prices saw declines, pointing to a possible peak in price pressures.
“Investors are looking for signs of moderation in supply chain disruptions, as declining input costs would ultimately signal an easing of the consumer’s price burdens. Recent economic data indicating shorter delivery times in the December ISM Manufacturing report and an easing of China factory gate prices have been supportive of ‘peak bottlenecks’,” said Comerica Wealth Management chief investment officer John Lynch.
The latest comments from Federal Reserve Chair Jerome Powell indicated that the central bank is willing to do anything to control inflation.
When testifying at his nomination hearing this week, Powell said that he sees “inflation pressures on track to last into the middle of this year.” And if inflation becomes more entrenched, the Fed will raise rates higher.
So far, Fed’s normalization policy includes the end of tapering in March, at least three rate hikes and a balance sheet runoff in 2022.
Powell also warned that a recession is possible if the Fed is forced to tighten too much. “If inflation does become too persistent, that will lead to much tighter monetary policy, and that could lead to a recession,” he said.
However, the Fed does seem to leave enough flexibility to adapt and change its mind once tightening begins.
The Bank of England is already fighting inflation with rate hikes, with the Bank pricing in price pressures rising above 6% in 2022. In December, the BoE raised rates by 25 basis points and the markets are projecting another four hikes in 2022.
The European Central Bank, in the meantime, is staying dovish, with president Christine Lagarde assuring the market that rate increases are not being considered this year. However, the latest inflation numbers are putting additional pressure on the ECB to act.
Is inflation about to peak?
Billionaire “Bond King” Jeffrey Gundlach pointed out that Fed Chair Powell gets more hawkish about raising rates every time he speaks. When looking at rising wage growth, the Fed does seem “pretty far behind the curve,” which explains its latest hawkish shift, Gundlach said during his webcast on Tuesday.
DoubleLine CEO Jeffrey Gundlach said he is now on “recession watch” as he cited inflation pressures and the Fed outlook.
“Inflationary pressure is building,” he said. “If we look at the economy … it’s undeniable that’s been supported by the quantitative easing and the Fed’s balance sheet expansion. And since that’s going away, it is just not plausible to think that we don’t have more headwinds in 2022 for risk assets and, ultimately, for the economy. The signals from the bond market are starting to look a little bit like a pre-recessionary period.”
Inflation will remain higher than what most people are projecting throughout 2022, Gundlach added. “Economists think it’s going to go back down to about 2.5% by the first quarter of 2023. That’s a little bit of wishful thinking when we’re starting up at around 7%,” he said.
Looking into year-end, inflation is likely to decelerate, avoiding the stagflation scenario of the 1970s, said CIBC World Markets managing director and chief economist Avery Shenfeld.
“The coming two years are unlikely to be a replay of that 70s show, with more growth, and less inflation, than what a stagflation label would imply. Even with an omicron stall in Q1, Canada’s growth should still be solidly in the 3.5% range in 2022, with the U.S. a touch higher, and while inflation will average above central bank targets, it will end the year at a tamer level,” Shenfeld said.
The latter half of 2022 is likely to see more growth, lower inflation, and a tighter monetary policy, Shenfeld added. “If, as we expect, March brings an improvement on the Covid front, that month will also mark the start of a tightening cycle by the Fed … aimed at keeping inflation running tame in 2023 and beyond as North America reaches full employment,” he said.
According to ING forecasts, inflation should start to slow in the coming months but will likely remain above 3% for the rest of 2022. “The assumption is that supply chain strains will start to ease from the summer onwards while the upside impetus from housing should fade as rising mortgage rates bite. Higher borrowing costs, in general, should start to take some of the steam out of the economy,” said ING chief international economist James Knightley.
Other analysts see a divergent story developing, with inflation rising in the U.S. and decelerating in China. “We raised our inflation forecasts, with risks still to the upside. In China, on the other hand, inflation figures for December point to an easing of inflationary pressures,” ABN AMRO economists said in a note.
The Dutch bank is now expecting CPI inflation to average 4.6% in 2022, up from its previous forecast of 3.9%. “As 2022 progresses, we expect a drag from core goods prices (mainly used cars) to be increasingly offset by higher services inflation. Last week’s payrolls report indicated an exceptionally tight labor market, with wage growth at 5.8% on a 3m/3m annualized basis. Such strong wage gains are only just starting to impact services inflation, and we expect the labor market to become a bigger – and more durable – driver of inflation in the months ahead,” said ABN AMRO senior U.S. economist Bill Diviney.
The situation in China is different as increases in the producer price index were driven by commodity-related sectors. “A relaxation of energy policy in Q4-2021 has already contributed to an easing of energy-related bottlenecks,” said ABN AMRO senior economist Arjen van Dijkhuizen. “We expect CPI … to remain well below the PBoC’s target of around 3%. All in all, the latest inflation developments provide room for the Chinese government to continue with piecemeal, targeted easing of monetary policy.”
A big test for gold
With inflation running so hot across the globe and central banks starting to take the threat of rising price pressures seriously, gold will meet its real test this year. Last year, gold declined largely due to a lack of investor interest. In 2022, all eyes will be on how the yellow metal performs as an inflation hedge asset.
“It could be argued that the bullish case for gold is its reputation as an inflation hedge, especially given central banks’ recent record for recognizing how severe the situation is,” said OANDA senior market analyst Craig Erlam. “But with inflation likely nearing its peak, that may not last. That said, fear around Fed tightening may also be peaking, which could support gold in the short-term, and a break through $1,833 could signal further upside to come.”
During the second week of the year, gold remained well supported even as yields around the world climbed in response to more hawkish tones from central banks. At the time of writing, February Comex gold futures were trading at $1,820.10, down 0.39% on the day.
Gold bulls are returning to the precious metal this week as inflation trade gathers attention, said FXTM senior research analyst Lukman Otunuga.
“The precious metal continues to draw strength from a weaker dollar and slight pullback in Treasury yields with prices trading around $1826 as of writing. Inflation risks could also be supporting upside gains for gold which has often been considered a hedge against rising prices. With inflation in the United States jumping in December, this could encourage some investors to hold onto their gold investments,” Otunuga said.
From a technical perspective, gold can move towards $1,845 if it closes above $1,831 an ounce. On the other hand, if it drops below $1,810, it can move towards to $1,800 and $1,770 an ounce, he added.
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