Were you confused or prepared?

Average inflation is a big paradigm shift

Published in

TRACKRECORD DAILY

7 min readAug 28, 2020

Yesterday’s price action is a perfect example of why trading is not a stroll in the park. Fed moving to average inflation targeting should weaken the USD and so the market tried that. However, moving to average inflation targeting will increase inflation expectations in the longer run and hence will lead to higher USD bond yields in the longer end of the yield curve, and so the market did that.

Higher USD bond yields often leads to a stronger USD, and so the market then did that and the retracement was especially fierce because almost everyone was bearish USD, and piled into selling USD as they reacted to the Powell’s speech.

And since Powell’s speech was widely anticipated, speculators were also positioned for this average inflation targeting change. So those who were well positioned and waiting, capitalised on the immediate USD weakness to reduce their risk and lock in some profits.

As the dust settled, what are we left with? A bunch of happy speculators who were prepared, a bunch of confused speculators who reacted blindly without considering market positioning and market expectations, and pretty much everyone else wondering what comes next.

It’s always difficult to be sure of the short term because of multiple factors playing a part. However, in the longer run, if we take a step back, the picture becomes clearer. Average inflation is a big paradigm shift. Read more about our thoughts in our Market Musings.

TRADING PLAN

Gold & Silver — Choppy overnight session, but Fed’s revised mandate of targeting average inflation should drive the price of hard assets higher in weeks ahead.
AUD -

AUD/USD — Trading at the top end of recent range and looks to test higher. Keep core long

AUD/NZD — Near term support at 1.0880–90 is holding. Keep core and added longs.

3. EUR/JPY — Trading at top end of recent range of 124.40–50 to 126.40–50. Reduce longs to allow for dip-buying and keep core longs..

Key risk remains higher US yields leading to a stronger USD. Could see position reduction into the weekend but stocks should remain bid.

WHAT HAPPENED YESTERDAY

Market Movements as of New York Close 27 Aug 2020

U.S. Initial jobless claims for the week ending August 22 were roughly in-line with expectations, decreasing by 98,000 to 1.006 million (expected 1.000 million). Continuing claims for the week ending August 15 decreased by 223,000 to 14.535 million.
The immediate reaction of Fed Chair Powell saying, as was widely expected, that the U.S. central bank would roll out an aggressive new strategy to lift U.S. employment and inflation, was a USD sell-off. EUR reached a high of 1.1900 and Gold above 1975. However, everything reversed as USD bond yields started to creep higher on fears of future inflation. Market positioning was short USD and that showed as speculators reduced position in a classic “buy the rumour, sell the fact” situation.
Under the new approach, the U.S. central bank will seek to achieve inflation averaging 2% over time, offsetting below-2% periods with higher inflation “for some time,” and to ensure employment does not fall short of its maximum level.
Financial stocks were among today’s biggest winners, benefiting from some curve-steepening activity after Fed Chair Powell outlined a shift towards an average inflation target.
Other positive factors included reports that Microsoft (MSFT 226.58, +5.43, +2.5%) and Walmart (WMT 136.63, +5.93, +4.5%) are teaming up to possibly acquire TikTok US, and Abbott Labs (ABT 111.29, +8.10, +7.9%) receiving emergency use authorization from the FDA for its $5.00, 15-minute COVID-19 antigen test.
Senate Majority Leader McConnell (R-KY) reportedly said stimulus talks remained at a stalemate, which may have been a contributing factor in the market’s brief dip into negative territory around 1:00 p.m. ET. The market, however, swiftly rebounded into positive territory.

HEADLINES:

FED TO TARGET 2% AVERAGE INFLATION, ELEVATES FOCUS ON JOBS

Fed on Thursday rolled out an aggressive new strategy to restore the United States to full employment and lift inflation back to healthier levels in a world where it now believes that “downward risks to employment and inflation have increased.”

Under the new approach, laid out in a fresh statement on the Fed’s longer-run goals and monetary policy strategy approved by all 17 of its policymakers, the U.S. central bank will seek to achieve inflation averaging 2% over time, offsetting below-2% periods with higher inflation “for some time,” and to ensure employment doesn’t fall short of its maximum level.

“Our revised statement reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities, and that a robust job market can be sustained without causing an unwelcome increase in inflation,” Fed Chair Powell said in prepared remarks for a speech explaining the changes.

With the U.S. economy in a deep economic crisis and just months before Americans vote in a contentious election, the Fed’s new approach is both an acknowledgment of fundamental changes in the economy that began well before the coronavirus pandemic, and a map for how the Fed plans to conduct policy in a world where weak growth, low inflation and low interest rates are seen as here to stay.

Thematic Context: “Inflation tends to operate with a lag and can be hard to correct once it starts. In the grand scheme of things, this is good for Gold and Silver, we continue to advocate that they are a buy on dips, the strong upward velocity of equities will transmit to Gold and Silver once the euphoria runs its course on the risk seeking asset class, although it’s still key to note that large supranational tech companies (AMZN, MSFT etc) are also seen as hard assets at this point in time.” — 21st May 2020

HURRICANE LAURA DEVASTATES LAKE CHARLES, LOUISIANA AS IT BARRELS INLAND

Residents of Lake Charles, Louisiana, heard Laura’s winds howling and the sound of breaking glass throughout the night as the storm passed through the city of 78,000 with winds of 85 miles per hour (137 km per hour) and gusts up to 128 mph (206 kph), in the hour after landfall.

The windows of the city’s 22-floor Capital One Tower were blown out, street signs were toppled and pieces of wooden fences and debris from collapsed buildings lay in the streets, video footage on Twitter and Snapchat showed.

The storm surge, which the NHC on Wednesday predicted would be “unsurvivable,” was still forecast to raise water levels up to 20 feet (6 meters) in parts of Cameron Parish, Louisiana, on Thursday morning.

Department of Homeland Security acting Secretary Chad Wolf told Fox News on Thursday that the Federal Emergency Management Agency (FEMA) had pre-positioned teams throughout Texas, Louisiana, Mississippi, Alabama and Georgia to respond as the sun rose.

SHOCKWAVES FROM WISCONSIN POLICE SHOOTING RATTLE U.S. SPORTS & POLITICS

Peace returned to Kenosha, Wisconsin, for a night but shockwaves from the police shooting that paralyzed a Black man reverberated across the United States, further polarizing the presidential election campaign and bringing major sports to a halt.

With protests elsewhere in America still lingering over the May 25 death of George Floyd, whose neck was pinned to the ground by a Minneapolis police officer, the Kenosha events revived debates about racism in the criminal justice system.

Authorities declared a state of emergency in Minneapolis on Wednesday to quell unrest that was stirred by the death of a Black homicide suspect who police say shot himself.

DAY AHEAD

Canadian GDP

In May, the economy showed a gain of 4.5%, bouncing back from a sharp decline of 11.6% a month earlier. Another gain is projected for June, with an estimate of 5.2%.