Interest Rate Hike Looms Larger | Gold and Bitcoin Rallies Nearing an End?

Producer inflation rising beyond expectations and persistent price pressures in the services sector have strengthened the likelihood of tighter Federal Reserve policy, adding fresh uncertainty to the outlook for global markets.

World Economy - Daniyal Rahimi; The release of two higher than expected inflation reports from the US economy on Wednesday and Thursday has once again increased investors' concerns about the sustainability of inflation. After the consumer inflation was published the other day beyond expectations, now the producer inflation has also been accompanied by a unprecedented jump and even the core indicators, excluding food and energy, have been higher than the forecasts.

The collection of these data shows that inflationary pressures are no longer limited to energy price increases and supply disruptions, and have spread to parts of the economy where it is more difficult to contain inflation.

Such conditions can make the Federal Reserve inclined to continue the strict monetary policy or increase the interest rate again; A decision whose consequences will be significant for the bond market, gold, bitcoin and US stocks.

Where did inflationary pressures come from?

The latest report of the US Bureau of Labor Statistics shows that the monthly producer price index (PPI) in September increased by 1.3% compared to the previous month; A figure that is more than twice the forecast of 0.5 to 0.6 percent of economists. In August, based on the revised figure, this index recorded a growth of 0.5 percent. September's increase was the largest monthly increase in producer prices since March 2022.

On an annual scale, producer inflation has reached 6.3% from 5.6% in August; Highest level since December 2022. This increase shows that the costs faced by companies in the stages of production and supply continue to grow at a significant rate.

A large part of this jump originated from the energy market. The prices of finished goods of producers increased by 2.6 percent in September, which is the largest monthly growth recorded since the collection began in 2009. More than 80% of the increase in the final goods index is related to the 10.8% growth in energy prices. Meanwhile, gasoline, with an increase of 20.3%, alone explains half of the price growth of this group.

Cost pressure has intensified in the earlier stages of production. The price of crude oil in the unprocessed intermediate goods sector has increased by 28.3% and the price of diesel in the intermediate processed goods sector has increased by 21%. These figures are important; Because the increase in the cost of energy in the production chain can be gradually transferred to the final price of goods through transportation, raw materials and distribution.

However, the worrisome part of the September report relates to rising prices after excluding energy and food. The producer core inflation, excluding these two groups, has increased by 0.7% on a monthly basis; while its growth was 0.2% in August.

Details of the service sector also reinforce this concern. The price of final services of producers increased by 0.8% and the cost of transportation and storage services experienced a growth of 3.4%. The profit margin of commercial services has also increased by 1.4% and price increases have been observed in road transportation, travel services and parts of wholesale.

Of course, the expansion of price pressures does not mean the complete independence of core inflation from the energy shock. The increase in the cost of fuel can be reflected in the price of transportation services and other economic activities. Despite this, the growth of non-energy commodity prices, cost of services and commercial profit margins show that the increase in oil prices cannot be relied upon to explain the current inflation; An issue that may force proponents of waiting for supply shocks to resolve in the economy to give up on their decisions.

As a result, the data of the last two days provide a relatively consistent picture of the US economy: inflation has accelerated at the producer level and there are not enough signs of a sustained reduction in price pressures at the consumer level.

Retail and unemployment insurance claimants

In addition to this information, the September retail sales report also indicates a 0.8% growth in sales value; Higher than the forecast of 0.3%, which shows that the American consumer still has good relative demand.

Excluding the effect of gasoline and car sales, the increase in retail sales is limited to 0.2 percent. Since this statistic is prepared based on the nominal value of sales, part of its increase can be due to the more expensive goods, and not all growth should be attributed to the increase in the actual volume of consumption.

On the other hand, the number of initial unemployment insurance claimants reached 199,000 people in the week ending October 10, and there was no significant change compared to the previous week. All of these data indicate an economy that, despite signs of demand adjustment, has not yet faced a massive increase in layoffs. This situation could leave the Federal Reserve's hand open to maintain a contractionary monetary policy.

the reaction of the markets; Is the upward trend of gold and bitcoin over?

The rise of inflationary concerns has made the US financial markets face two opposing forces. On the one hand, the possibility of a further increase in interest rates works in favor of the dollar and the yield of short-term bonds, and on the other hand, the decrease in the willingness of investors to accept risk can increase the demand for treasury bonds and gold. The outcome of these two forces will determine the path of asset prices.

Strong fluctuations have been observed in the gold market. Global gold fell about 1.8% to $4084 an ounce following the release of the Consumer Inflation Report on Wednesday. An initial rise in bond yields and a strengthening dollar reduced the interest-free metal's appeal.

However, gold recovered some of its losses in Thursday's trading before the release of producer inflation and returned to the $4,157 range with an increase of about 1.3%. Lower bond yields and stronger demand for safe assets supported this return.

Now the new producer inflation report can be an important test for the continuation of this trend. If investors consider the increase in core inflation as a sign of the need for higher interest rates, there is a possibility of an increase in real bond yields and pressure on gold again. On the other hand, if concerns about economic growth or the continued fall in stocks strengthen the demand for safe bonds and yields fall, gold can find support from these conditions. But this support is only short-term and for now, with the current conditions, different variables are working against the growth of gold.

But Bitcoin is in a different position. The flagship of the crypto market was under pressure in Thursday's trading and reached the $80,743 range with a decrease of about 1.2%. At one point, the price of this asset fell back to 80 thousand 247 dollars and approached the lowest levels in the last month.

Unlike gold, Bitcoin typically does not receive stable support from safe-haven demand during periods of reduced risk appetite. Rising yields on interest-bearing assets, the possibility of tighter liquidity conditions, and falling tech stocks could weaken demand for cryptocurrencies. Of course, the intensity and stability of this relationship depends on the market conditions and capital flow.

In the US stock market, the conditions before reopening were not very favorable. Nasdaq futures were down 1.2-1.3 percent and S&P 500 futures were down nearly 0.3 percent. If this situation continues until the start of cash transactions, the re-opening of these two indices with a negative price gap is likely; Especially since stocks of technology and artificial intelligence companies have been under selling pressure before.

Increasing the probability of high interest rates reduces the present value of expected profits of growth firms. This issue is more important for technology companies, where an important part of their valuation depends on the revenues of the coming years. Companies that rely on heavy financing to develop their AI infrastructure may also face increased cost of capital.

The most important message of the data of the last two days should be found in the change in monetary policy expectations. According to the market's expectation, the probability of interest rate increase in the meeting of October 27 and 28 has reached 33.8%; While this probability was only 17.7 percent a week ago.

In other words, within a week, the market has assessed the possibility of an interest rate increase in October by 16.1 percentage points higher. However, the probability of stabilization of the interest rate in the current range of 3.75 to 4% is still 66.2% and is considered the dominant scenario for the October meeting.

The change in expectations for the December meeting is more dramatic. The market predicts that the interest rate will be in the range of 4 to 4.25 percent by the end of the meeting on December 8 and 9 with a probability of 63.2 percent; A situation equivalent to an increase of 0.25 percentage points compared to the current rate.

Meanwhile, the probability of the interest rate being in the range of 4.25 to 4.5 percent, equivalent to two increases of 0.25 percentage points by the end of the year, has reached 30.6 percent. This probability was 13.7 percent a week ago. The probability that the interest rate will remain at the current level until the end of the December meeting is estimated to be only 6.2%.

Therefore, although the market still sees a rate stabilization in October as more likely, the probability of at least one rate hike by the end of the year has risen to 93.8%.

The difference of opinion between financial institutions and Federal Reserve officials also shows that the timing of the interest rate increase is still a matter of discussion.

In contrast, San Francisco Federal Reserve Chair Mary Daley has emphasized the lack of immediate action in October, while acknowledging the possibility that more interest rate hikes may be needed. This difference is more related to the speed of the Central Bank's reaction and the need for more information than the principle of inflation risk.

From an economic perspective, the Fed's decision will depend on how cost pressures are passed from producers to consumers. If firms can pass on rising energy, transportation and raw material costs to final prices and core inflation remains high in the coming months, the likelihood of tighter monetary policy will increase.

The Fed should also consider the implications of another interest rate hike for the labor market and the cost of funding. The high yield of treasury bonds, even without the new action of the central bank, has made part of the financial conditions of the economy a little tighter. If this trend leads to a decrease in investment and employment, the necessity of a rapid increase in interest rates can be questioned again.

However, September's data has made one fact clear: the path for US inflation to return to the 2% target has become more difficult and markets can no longer base their decisions on a sustained reduction in price pressures.

Overall, the more likely scenario for the market is still the stabilization of the interest rate in October and its increase until the end of the year; But the continued growth of core inflation could change this timing. Now the main issue for the Federal Reserve is not only to contain the spike in energy prices, but also to prevent production cost pressures from turning into persistent inflation across the US economy.