If the Fed Tightens Too Much, They Will End up With an Equity Market Crash
Inflation will return with a vengeance», said Louis-Vincent Gave in this interview with The Market one year ago. At the time, hardly any forecaster had expected annual inflation in the U.S. to rise all the way to 6.8%
When you look at the macro picture today, what are the most important developments?
The starting point is that inflation has come back. Financial markets haven’t really responded massively to the high inflation readings though, at least until now. We haven’t seen a big impact on currencies, bond yields stayed the same, gold did nothing, and US growth stocks continued to outperform. Most of these asset prices have not moved the way one thought they would in the face of higher inflation.
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Given this backdrop, wouldn’t you say that the bond market would have to revolt and claim higher rates?
If you asked me a year ago, I would have said yes, for sure. But now my conviction is shaken, to be honest. We have 6.8% inflation and the bond market just yawns. Why? I think one reason is that pension funds, life insurance companies and banks don’t have a choice but to buy government bonds. They are being forced by regulation. This is almost textbook financial repression. Back in the 50s and 60s, we also had capital controls, which we officially don’t have today. But it’s getting harder to move large amounts of money across borders, your ability to escape financial repression is disappearing. In the old days, you could be sure that at least Switzerland had a sound currency and positive real rates. But where should you go with your money today? Everybody has got negative real rates. The Swiss franc is still a strong currency, but Switzerland is offering negative real – even negative nominal – rates, just like everyone else.
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Let’s think this scenario through: The dollar will roll over some time in 2022, and we’ll see more stimulus in China. This sounds like a good environment for emerging markets and commodities, right?
I think so, yes. What’s been fascinating about the commodity complex is that it has been pretty strong for the past 18 months in spite of a slowing China. I think the reason is that this bull market is not so much driven by roaring demand, but by a lack of supply. We have massively underinvested in all sorts of commodities, including energy, since the last commodity boom went bust in 2011. If you think of a world in 2022, where the coronavirus becomes endemic and we learn to live with it, we’ll have the release of pent-up demand in the US and Europe, and we’ll have some stimulus in China, with good growth around the world: First, I don’t see inflation coming down that much, and second, what you want to own in this kind of world is commodities, where a lack of supply will be met by roaring demand.
What will need to happen for gold to rise?
At the end of the day, gold is a derivative of emerging markets. A third of the physical demand for gold in the world is from India, almost a third from China, 20% from the Middle East and another 6 or 7% from Russia. People who buy gold are in emerging markets. When they get richer, the demand for gold far outstrips supply. One of the frustrations of 2021 was that gold did nothing. But remember that China has been slowing hard, while India had a really bad Covid wave. If you think that 2022 is a year where the dollar stops rising because the Fed will turn out to be not as hawkish as people think, that China stimulates some, emerging markets will do pretty well, plus a rising commodity demand, I think gold will break 2000 $.
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