The document discusses how 2021 is shaping up to be the "year of the hike" for interest rates as the Federal Reserve begins tightening monetary policy earlier than expected. It notes that the Fed will likely taper its asset purchase program sooner in response to inflation rising above forecasts. The document also analyzes how higher rates and reduced liquidity could impact precious metals as the amount of liquidity the Fed provides declines. It concludes that signs of diverging messaging among Fed officials suggests a climax in monetary policy is approaching.

1. Gold: The FED’s Year of the Hike

2. Points To Be Covered Today:
• The FED’s Year Of The Hike
• Inflation & Goldilocks Environment
• YoY% Change In Commodity PPI Vs. Headline PCE
• Reverse Repurchase Agreement
• FED Fund Rate Vs.UST2Y
• Trends Are Changing
• Watch For Out Of Tune Singing

3. The FED’s Year Of The Hike
• The FED knows it has to taper soon, but won’t tell this blatantly. However, people
started to notice. What does this mean for the precious metals?
• The Talk of the Town
• While I’ve been warning for months that the U.S. Federal Reserve (FED) will likely
taper its asset purchases much sooner than investors expect, the gossip has
finally reverberated across the financial markets.
• To explain, I wrote on Jun 21:
• With the FED’s announcement turning the financial markets upside down, the U.S.
10-Year Treasury yield’s rollercoaster performance didn’t capture the magnitude
of the move.
• For example, with the front-end of the U.S. yield curve becoming increasingly
unhinged, the U.S. 2-Year, 3-Year and 5-Year Treasury yields surged by more than
62%, 38% and 12% respectively following the FED’s announcement.

4. 2- Year US Treasury Yield

5. Inflation & Goldilocks Environment
• “Much of the consensus of professional forecasters in February was that we would have
inflation just above 2% this year,” he said.
• “We’ve already had more inflation than that in the first five months of the year. This
suggests that people should not just modify their forecasts but should think about what
their errors of thinking were that led them to be so far off in their forecasts.”
• Piling on the poor FED, former U.S. Treasury Secretary Steven Mnuchin added on Jun 21
that “there’s no question the FED needs to go into a period of normalizing rates and
normalizing the portfolio … and I do think the markets are underestimating this risk.”
• And why does he believe that?
• Well, for one, Bank of America’s latest Global Fund Manager Survey revealed that
institutional investors are “bullishly positioned for permanent growth, transitory inflation
and a peaceful FED taper.”
• Essentially, they expect a Goldilocks environment. And with that, the narrative is that
inflation has already peaked

6. Inflation Expectations Have Peaked

7. Inflation Expectations Have Peaked
• The blue line above tracks the net percentage of investors
forecasting a higher global Consumer Price Index (CPI).
• If you analyze the right side of the chart, you can see that
the blue line has fallen considerably from its prior high.
• However, with the Personal Consumption Expenditures (PCE)
Index scheduled for release on Jun. 25, another inflationary
surprise could be lurking around the corner.

8. Inflation Expectations Have Peaked - I
• the FED increased its year-over-year (YoY) headline PCE Index forecast
from a rise of 2.40% YoY to a rise of 3.40% YoY on Jun. 16.
• However, with the Commodity Producer Price Index (PPI) surging by
18.98% YoY – the highest YoY percentage increase since 1974 – the
wind still remains at inflation’s back.
• Moreover, with all signs pointing to a YoY print of roughly 4% to
4.50% on Jun. 25, the “transitory” narrative could suffer another blow
on Friday.
• If we begin with the reported figure [an 18.98% YoY increase], the
commodity PPI implies a roughly 4.50% YoY increase in the Personal
Consumption Expenditures (PCE) Index.

9. YoY% Change In Commodity PPI Vs. Headline PCE

10. YoY% Change In Commodity PPI Vs. Headline PCE
• To explain, the green line above tracks the YoY percentage change in
the commodity PPI, while the red line above tracks the YoY percentage
change in the headline PCE Index.
• If you analyze the right side of the chart, you can see that a material
gap is clearly visible.
• What’s more, if we substitute the 18.98% jump with the non-base-
effects comparison of 12.60%, it still implies a rise in the headline PCE
Index of roughly 3.60%.

11. Fed’s Tightening Cycle
• Furthermore, while investors aren’t paying much attention, the FED’s
tightening cycle has already begun:
• The New York FED announced on Jun. 3 that it “will begin gradual
sales of its holdings of corporate bond exchange- traded funds (ETFs)
on June 7.”
• The FED increased the interest rate on excess reserves (IOER) from
0.10% to 0.15% on Jun. 16.
• The U.S. federal funds rate rose from 0.06% to 0.10% on Jun. 17.
• The FED sold a record $765 billion worth of reverse repurchase
agreements on Jun. 21.

12. Reverse Repurchase Agreement
• To explain, a reverse repurchase agreement (repo) occurs when an institution offloads
cash to the FED in exchange for a Treasury security (on an overnight or short-term basis).
• And with U.S. financial institutions currently flooded with excess liquidity, they’re
shipping cash to the FED at an alarming rate.
• More importantly, though, after the $400 billion level was breached in December 2015,
the FED’s rate-hike cycle began.
• On top of that, the liquidity drain is at extreme odds with the FED’s QE program. For
example, the FED aims to purchase a combined $120 billion worth of Treasuries and
mortgage-backed securities per month.
• However, with daily reverse repurchase agreements averaging $520 billion since May
21, the FED has essentially negated 4.33 months’ worth of QE in the last month alone.
• Likewise, I noted at the beginning that the U.S. 2-Year Treasury yield surged by more than
62% following the FED’s announcement on Jun. 16.
• And with the short-term benchmark exhibiting a correlation of 0.98 with the U.S.
federal funds rate since 1977, further momentum could have the FED sweating bullets
over the summer.

13. FED Fund Rate Vs.UST2Y

14. FED Fund Rate Vs.UST2Y - I
• To explain, the green line above tracks the U.S. 2-Year Treasury yield,
while the red line above tracks the U.S. federal funds rate. If you
analyze the relationship, you can see that the two often follow in
each other’s footsteps. Thus, if the former continues its rally, the FED
may find itself behind the interest rate curve.
• To that point, Hans Mikkelsen, credit strategist at Bank of America,
told clients on Jun. 21 that he expects the FED “to soon begin
tapering its [QE] purchases, and to start hiking interest rates earlier
than expected – and, most importantly, much faster than currently
priced in the markets,”

15. Trends Are Changing
• In addition, while 2020 was the year of the cut, 2021 is shaping up to be
the year of the hike.
• To explain, 195 global interest rate cuts were witnessed in 2020 with only
five hikes offsetting the dovish nirvana. Conversely, in 2021, we’ve already
witnessed 19 global rate hikes and only eight offsetting rate cuts.
• As a result, not only is liquidity drying up in the U.S., but the global faucet
is also starting to creak.
• On top of that, with rising interest rates spelling trouble for the PMs over
the medium term, the reduction in liquidity could spur volatility across
U.S. equities and exacerbate the PMs’ potential selling pressure in the
coming months.

16. 19 Rate Hikes Thus Far In ‘21 Vs 5 in ‘20

17. Federal Reserve Total Assets As Percent Of Total US Market

18. Federal Reserve Total Assets As Percent Of Total US Market - I
• To explain, the blue line at the top half of the chart tracks the FED’s balance
sheet, while the blue line at the bottom half of the chart tracks the FED’s
balance sheet as a percentage of U.S. equities’ total market cap.
• If you analyze the right side of the chart, you can see that the FED’s
influence peaked in 2020 and has been in free fall ever since.
• Moreover, with the central bank poised to tighten the liquidity screws in
the coming months, a reenactment of late 2018 could weigh heavily on the
PMs.
• From a valuation perspective, Bank of America’s Global earnings per share
(EPS) model signals that growth peaked in April 2021 and that weak
quarterly prints could result in high volatility over the next 12 months.

19. Watch For Out Of Tune Singing
• Finally, while I’ve
mentioned on several
occasions that FED
officials already know
that they have to
taper (they just don’t
want to disclose it
publicly and cause a sell-
off in the stock and bond
markets), their divergent
messaging is another
sign that a climax is
approaching.

20. Gold: The FED’s Year of the Hike

21. Thanks for listening
Gold: The FED’s Year of the Hike