Start of 2024 Market Comments

From the HRA Special Delivery: Issue 1238

Happy New Year!  As it turned out, I was not able to organize the planned zoom call with LUCA. We couldn’t make dates work and Struthers had software and hardware issues. We will be doing that on Tuesday, but it’s getting pretty silly waiting for it. I plan to do a couple of other zoom calls, with Vizsla and VRR and perhaps one or two others. Not firmly scheduled yet, but also likely mid-week. I may bundle a few of those together in one SD, depending on what other news arrives in the meantime. Week one of 2024 was quiet, news-wise, for the HRA list but I expect things to pick up this week.

I did not bother with the usual self flagellation that is a “yearend special issue” as I did not have anything new to say that I haven’t said already in the past few weeks. The situation with future rate cuts is still very fluid, or at least I think it is.  That is impacting all markets.   This week’s ISM readings, both service and manufacturing gave some credence to the story of a slowing economy though, as usual lately, the picture was mixed. Yes, the manufacturing ISM reading was pretty weak, but it’s been in contraction territory for a year and a half, and the US economy is still chugging along. Not sure what to make of that, other than its another reminder that services rule the roost now.  ISM Services was not contractionary, though it is getting closer with a reading of just 50.6, just above the 50 reading that implies no growth, and below November’s 52.7 reading.  This heartened traders that had just been a bit spooked by a stronger than expected non-farm payrolls reading. The Service PMI employment number, at a weak 43.3, seemed to be especially welcomed.

Non-farm payrolls had a bit of something for everyone, which helps explain the wild swings in markets around its release.  The headline number was notably stronger than expected, with a gain of 216k, rather than the 170k consensus estimate for increase in jobs. But the prior two months had big downward revisions totalling 71k jobs, the sort of thing often seen late in an employment cycle. To add to the dichotomy, the month over month increase in hourly wages did not drop as expected, coming in at 0.4% again.  The unemployment rate dropped 0.1%, but the participation rate dropped even more, by 0.3%, another surprise.

All this contradictory info had bond traders downright schizophrenic, generating wild swings from the release of the NFP through the PMI release to the end of the trading day.  The confusion was only added to by an extremely weak “household survey” number, which indicated job losses of over 600k for December, the worst number since  the pandemic lockdowns. The Household survey is used to generate the unemployment rate but it is extremely volatile and I’m leery about reading too much into it. That said, the ISM Service reading for hiring intentions, presumably more forward looking, was extremely weak, the sort of reading you see when the economy is headed for recession.

The chart above shows the trace of the 10-year yield on Friday. Yeah, just on Friday. The swings were crazy though, at the end of the day, the move was not large.  Traders really liked that weak PMI employment reading, though most of the gains in bond prices were given back later. Likewise, the strong NFP number spooked bond traders but they started questioning the data immediately and yields were only slightly above their level before the NFP release when the PMI numbers came out.

I think we’d better get used to this sort of bipolar market activity.  Sentiment seems to be on a knife edge lately. Sentiment about the speed and depth of rate cuts has been the driver for Wall St. and by extension, the bond and gold markets. The chart on top of the next page shows the trace of the implied odds of a 25-basis point rate cut at the FOMC meeting in March.  The odds of a cut soared after the December FOMC meeting that traders read as uber dovish.  In that, it continued the trend from October that saw the 10-year yield drop by over a percentage point to 3.8%  That ended with stronger readings after Christmas that looked like they have killed Santa, or at least the Santa rally.

The odds of a cut in March reached 90% in late December but fell as low as 50% after Friday’s NFP release.  The chart below does not show the end of day recovery after the PMI report, which lifted the odds of a cut in March back near the 70% level.

All this talk about yield curves and macro readings is not academic for gold traders.  On the contrary, there is good correlation between the implied odds of a March rate cut and the spot gold price chart. The second rally in the gold price through late December top out at the same time as the rate cut odds.  Gold has pulled back to the $2040 level, still pretty good given the move in yields, but its forward price will very much depend on how yields and the USD move.

For all the short-term drama, the overall view of how 2024 will evolve when it come to rates hasn’t changed that much yet. While the curve has flattened a bit, the bond market still expects six cuts this year. That should be more than enough to support gold prices, especially once cuts actually start. You can see the changes in the implied number of 25-basis point cuts before US elections in November in the chart above.  Less favorable than a month ago, but it looks less scary in this presentation.

While we still are not seeing recessionary or near-recessionary conditions I think are required for six rate cuts this year to become reality, I agree with the idea some real weakening is starting to show. It looks like Q4 2023 growth will come in the 2.5% range.  Hardly a disaster, but readings like the ISM hiring intentions point so some slowing starting now. Some important readings for the gold market, notably central bank buying, are more lagging, but I don’t get the sense that buying has slowed and it’s a major market support. We have no concerns about sentiment being too bullish in the gold market, that’s for sure.  There are still no meaningful inflows to more “retail” gold favorites like GLD.  I’d rather not see recent lows in the gold price tested but I am ok with the fact the market isn’t buying into the gold rally.  That  sort of skepticism is what drives longer and stronger rallies.

Gold has held up well, but we need to see more weak macro numbers to keep things moving.  Expect volatility to be high because of how uncertain the market is. If central bank buying continues and the current view that we will get six rate cuts turns out to be true, there is room for gold to move a few hundred dollars higher.  I’m still not sold on a March rate cut, personally, but a low CPI reading this week and higher weekly unemployment claims – which still have not arrived – would help convince me.  Consolidating above $2000 is a good thing, but we may need a new catalyst of some sort to push gold through $2100. So far, so good.

Regards for Now,

Eric Coffin

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