Another Difficult Month for the US Economy

Like April, May has brought little cheer to the equity markets with inflationary pressures, and the Fed’s measures being taken to try and control them, seeming to be inevitably driving the US economy into a period of stagflation, possibly even followed by recession. Even the dreaded prospect of a depression to match that of 1929-30 is on some economists’ lips.

Stagflation is defined as a period of stagnant growth coupled with high inflation, usually triggered by a sharp rise in energy prices – much as we are seeing today. The fall in unemployment as the US economy began to recover from the Covid-19 pandemic tended to counter this trend, but there is some evidence that this is beginning to turn around again as inflation eats into disposable incomes and consumer spending begins to turn down cutting demand for goods and services. Whether this turns into a full-blown recession is rather less certain, however.

Past evidence suggests that recession does not usually follow a period of stagflation. But a program of 50 basis point interest rates increases at successive Federal Open Market Committee (FOMC) meetings, as the Fed seems to be planning, may be sufficient to trigger sharp falls in equity prices across the board and be instrumental in tipping the whole US economy into a recessionary downwards spiral. Equity downturns can be sharp and severe as we saw in the middle of the past month when the Dow lost around 1,500 points over a 2-day period. Even though we have seen partial recoveries in equities since, similar sharp downturns can not be ruled out in the weeks and months ahead. A fall in the Dow to below 30,000. The S&P 500 to under 3,750 and the Nasdaq to less than 10,500 over the next month or two cannot therefore be ruled out.

Precious metals seem to have made something of a recovery, but not yet a significant one. Gold moved back above $ 1,850 at the beginning of the past week, but was struggling to hold on to this level, while silver and the pgms continued volatile. Precious metals stocks have tended to outperform their respective metal prices, but only marginally so. Certainly the major precious metals miners should be making strong profits at current metal price levels.

The wild card here seems to be dollar strength. A strong dollar tends to indicate a weaker gold price in US dollar terms, and the dollar has tended to move upwards against competitive currencies in recent weeks despite apparent weakness in the US economy. This may not necessarily continue and there were some signs of a developing dollar downturn towards the end of the past month.

Data released during the month suggested that US Q1 GDP turned negative and the latest projection by the Atlanta Fed is that the Q2 GDP growth estimate has shrunk to a mere 1.8%. Given how unexpected the Q1 fall was it might be no surprise if the Q2 figure ends up flat, or even negative too, and if the latter would tip the US economy into a technical recession. We do not necessarily expect that this will happen, but investors should perhaps be prepared for the possibility and any negative market connotations resulting.

There is some speculation also that China and Russia, as the world’s top two gold producers by some estimates, may be attempting to introduce a gold-backed global reserve currency to rival the dollar’s dominant reserve status. Should this speculation be accurate, and a new such reserve currency find acceptance, then the dollar could well enter a period of value decline globally, which would certainly benefit the gold price, at least in dollar terms.

Inflationary trends seem likely to continue to influence equity and precious metals markets despite proposed Fed actions on tightening and interest rate rises. Markets are thus likely to remain volatile as they have been over the past couple of months and will be moved up and down by data releases seen as positive or negative. Equities and bitcoin may well thus continue depressed overall, while gold, in particular, may catch an upwards bid as markets consider the underlying trends. However, uncertainty will likely continue to reign until we see a definitive move by one or other of the key market components.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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