Despite a recent boost from the Israel-Hamas conflict, the outlook for the yellow metal appears less robust due to domestic economic concerns.
Substantial Drawdowns on the Horizon
The surge in inflation, coupled with rising U.S. Treasury yields and a strengthening USD Index on October 12, continued to exert pressure on precious metals. While geopolitical concerns in the Middle East led to a rebound in gold, underlying economic fundamentals remain consistent with the medium-term forecast.
Notably, PIMCO, a significant investment firm, released its Cyclical Outlook report on October 11, aligning with the view that inflation is not the central concern but rather weak economic growth. The report mentioned, “We forecast core inflation in the 2.5%–3% area in the U.S. and Europe at the end of 2024. We anticipate that falling growth and rising unemployment will lead to more disinflation, helped also by other factors.”
The expectation of non-transitory inflation driving the Federal Reserve’s rate-hike campaign has led to uncertainty and weakness for assets such as silver. Furthermore, the rise in real yields carries economic implications, potentially causing issues in the coming months. PIMCO’s report added, “We analyzed 140 tightening cycles across developed markets from the 1960s through today. When central banks hiked policy rates by 400 basis points (bps) or more, almost all such instances ended in recession.”
Hence, the narrative that most assets are currently priced as if inflation will swiftly dissipate and result in minimal economic damage may not hold true. If (when) this narrative falters, the USD Index could surge, leading to substantial drawdowns in precious metals.
Challenges in the Housing Industry
The housing industry has started to sound the recession alarm, emphasizing that higher long-term interest rates, as opposed to the Federal Funds Rate, are responsible for negative economic growth. On October 9, the National Association of Home Builders, the Mortgage Bankers Association, and the National Association of Realtors penned a letter to Fed Chairman Jerome Powell, urging him to halt rate hikes. The letter noted, “The speed and magnitude of these rate increases, and resulting dislocation in our industry, is painful and unprecedented in the absence of larger economic turmoil.”
Furthermore, the letter indicated the harmful effects of the mortgage-to-Treasury spread, impacting homebuyers. The uncertainty-induced spread has cost homebuyers an extra $245 in monthly payments on a standard $300,000 mortgage. Additional rate increases and a persistently widespread situation pose broader risks to economic growth, increasing the likelihood and magnitude of a recession.
Despite these challenges, the Fed’s options to address the situation are limited. The central bank does not control the long end of the yield curve, and adopting a dovish stance could worsen inflation. As a result, the longer long-term rates remain high, the more they will stress consumers and economic growth, heightening the risk of a recession. This situation could particularly impact the oil sector over the medium term.
Finally, the Federal Open Market Committee (FOMC) released the minutes from its September 19-20 monetary policy meeting, highlighting the consensus that policy should remain restrictive to ensure inflation moves down sustainably. This commitment to maintaining a hawkish approach is likely to impact economic growth, with historical trends suggesting silver and mining stocks will be among the most affected when economic-induced volatility intensifies.
In summary, the recent interest rate spike and a sea of red in various risk assets on October 12 signal that long-term interest rates will continue to constrain the real economy. As the full effects become evident, it’s expected that the S&P 500 may face considerable challenges.
