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Fed pivot hinges on stock market selloff, says Bloomberg Intelligence

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(Kitco News) With all eyes on the FOMC May meeting minutes, Bloomberg Intelligence said that a pivot by the Federal Reserve depends on a renewed selloff in the stock market.

"[There's been a] cat-and-mouse game between federal funds futures in one year (FF13) with rate expectations rising along with the S&P 500," Bloomberg Intelligence senior macro strategist Mike McGlone said. It could take a lower stock market for the Fed to pivot."

And there are signs that the equities space has more to fall. "The S&P's 52-week moving average at the end of 2019 was 2,918 vs. the current level at about 4,140 on May 15 could imply reversion potential," he said in a note Wednesday.

Also, the Fed follows the lagging inflation measures when making its monetary policy decision, while the leading commodity indicators point to an enduring deflationary trend, McGlone pointed out.

"The trailing nature of inflation measures guiding the Federal Reserve vs. leading markets like commodities may have enduring deflationary implications. Rising rate-hike expectations along with the stock market could portend an economic lose-lose, fueling the typical inevitable long and variable lags to gain momentum," he said.

The Bloomberg Commodity Spot Index is already down around 26% year-on-year, which could mean deflation. And the expectations for another 25-basis-point rate hike in June are at 25%.

"Plunging commodities may be a precursor for severe deflationary forces on the back of a vigilant Fed focusing on sticky and lagging inflation measures," McGlone pointed out. "A body in motion with plenty of fuel is how we see falling commodities, if central bank liquidity and economic cycles are a guide. Typically it takes a lower price plateau to squash supply and buoy demand, and a decent lag to central-bank easing for commodities to stabilize."

One indicator to watch is natural gas, which dropped below its 2019 average price in the U.S., and that could have implications for other commodities, deflation, and recession, McGlone noted.

"The rule that commodities return to their marginal costs of production is playing out in natural gas, which in the U.S. is around $2, based on data from BTU Analytics. In WTI crude oil, the breakeven cost is about $50," he said.

McGlone also sees gold outperforming other commodities this year, including silver, platinum, and palladium. The yellow metal will likely accelerate its rally in the second half of 2023.

And despite the recent selloff, gold's performance so far is encouraging, up around 5.3% during the last 12 months. In comparison, the Bloomberg Commodity Spot Index (BCOM) is down about 26% during the same period.

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