(Kitco News) The more enduring problem in the post-COVID world is not inflation but disinflation, Bloomberg Intelligence said, warning that commodities are looking at more downside.
"Disinflation is typical in recessions," said Bloomberg Intelligence senior macro strategist Mike McGlone on Wednesday. "The propensity for inflation measures to come out weaker than expected may be more enduring than the recent surprises to the upside."
This new year is being defined by the removal of liquidity at an unprecedented pace. And it all started in 2020 with the Federal Reserve's historic tightening cycle that followed massive money injections into the economy that were one of the triggers behind the surge in inflation in the first place.
And what the markets are already witnessing in January is a reversion of inflation, commodities, and risk assets.
"The ISM services purchasing managers index has never dropped below 50 with the Fed tightening, and that has implications for commodities, inflation and most risk assets," McGlone said Wednesday. "The Bloomberg Commodity Index (BCOM) may be about 35% too high relative to its 40-month moving average, based on past trends in the purchasing managers index since 1998."
Looking into the months ahead, the outlook remains the same - the ISM services and manufacturing continue to contract and the Federal Reserve keeps hiking rates, at least for now.
"There may be little support for the BCOM until around 20% below this mean, and it was about 15% above on Jan. 10," McGlone wrote. "The BCOM has a tendency to put in enduring peaks at about 70% above and bottoms around 20% below its 40-month mean."
Monetary policy tightening followed by a recession could reignite some of the dominant pre-COVID trends in commodities and inflation.
"The fact that the Bloomberg Commodity Spot Index and S&P 500 are falling from similar heights and velocity as in 2008-09 may have implications for inflation. A key difference is the Fed is still tightening," McGlone said. "The wealth effect from rising equities and the more direct inflation connection from commodities may be facing superior reversion forces."
Considering how markets typically work, a quick drop in inflation is likely as commodities and stocks keep falling in response to the U.S. money supply contracting at a rapid pace, McGlone concluded.
Looking at crude specifically, Bloomberg Intelligence said oil is currently overvalued versus the stock market.
"Liquidity and inflation are receding from markets at a record pace, as evidenced by the S&P's drawdown of about 25% from its peak," McGlone said. "With crude oil and the S&P 500 still up about 20% to Jan. 10 since the end of 2019 (before the pandemic), both may need to continue to decline to arrest inflation and central-bank tightening. We see risks tilted toward crude continuing the deflationary trajectory from 2H."
For gold, the situation is different in 2023, with Bloomberg Intelligence projecting for the yellow metal to breach the $2,000 an ounce level and "never look back."
"This is our base case for the precious metal, notably as the Fed shifts from the highest-velocity tightening period in 40 years toward easing," McGlone said at the end of December. "We see risk vs. reward leaning toward gold continuing its upward trajectory, notably vs. copper."
