Bad Week for Inflation Proxies

Last week, during his first press conference as Fed Chair, Kevin Warsh went to great lengths to lay out his inflation-fighting bona fides.  As we noted the following day, rate-hike expectations soared, bringing short-term rates higher along with them.  Although key stock market measures have not broadly welcomed the Chair’s tonal shift –through yesterday, both the S&P 500 (SPX) and Nasdaq 100 (NDX) were each down about 2% since the day prior to the FOMC meeting – prices of assets that tend to act as inflation hedges have suffered more.

Foremost among them are the prices of oil futures and energy stocks.  Those declines are of course primarily the result of negotiations to reopen the Strait of Hormuz and to end the war in the Persian Gulf, but they certainly contribute to lower global price pressures.  Crude futures prices had already been in a steep, steady decline, but in the week that ended yesterday, August WTI (CL) and Brent (CO) futures fell by 4.4% and 3%, respectively.  (They’re both down by another 4% today, by the way.)  Energy stocks, however, have already priced in much of those declines, with the Energy Select Sector Total Return Index falling by less than 1% over that span.

Other inflation proxies are not faring well either.  Gold fell by 4.9% in the week from the day prior to the FOMC meeting through yesterday, and it is down by another 2.7% this morning, after briefly trading below the $4,000 level.  Again, there are extenuating factors behind that decline.  We have noted that gold has a tendency to act as an “antidollar.”  All things being equal, commodities that are denominated in US dollars tend to have an inverse relationship with the currency.  A stronger dollar means that fewer of them are required to purchase the quantity of commodities represented by a futures contract, and vice versa.  This is of course only one of the factors that influence commodity prices, but gold’s historic role as a store of value makes it more sensitive to changes in the dollar than most.

For better or worse, bitcoin, or “digital gold,” is keeping pace with the yellow metal.  It was also down about 5% in the prior week and is falling by an additional 3% this morning.  Again, there can be factors that are specific to bitcoin and to cryptocurrency overall, but if it can be thought of as an inflation hedge, this decline would be evidence of reduced inflationary pressures.  Or, like gold, it can be falling victim to the combination of a stronger dollar and higher rates.

Yes, a key to all these moves is the dollar.  Driven by easing geopolitical tensions and higher short-term rates, DXY, a US dollar proxy index, rose by nearly 2% during the prior week.  Higher rates boost the price of a currency versus its counterparts, and the rise in 2-year yields boosted the appeal of the USD.  In turn, a stronger dollar can act as a headwind for the multinational stocks that dominate major US stock indices.  They tend to generate revenues in a wide variety of foreign currencies, and a stronger dollar means that those revenues are worth marginally less when translated back into their home currency. 

It’s all quite circular.  We start with a worthy goal – lower inflation – and we end up with a set of financial outcomes that seem adversely affected by the measures taken to achieve it.  Markets will eventually sort out the various crosscurrents, but in the meantime, don’t be surprised if we see a bit more volatility until that occurs.