CNBC/Jeff Cox
Why the Fed’s inflation push could turn from friend to foe for the market this year

The Federal Reserve enters the new year with a fresh challenge on its plate, namely whether its commitment to higher inflation will bring power or poison to financial markets.

Wall Street kicked off 2021 with its worst first trading day showing in years, as major averages slumped Monday at a time when investors were still counting on the last days of a Santa Claus rally.

While some pundits looked at political uncertainty as a major underpinning for the plunge, an inflation trade also was at work.

A key indicator, which looks at the relationship between Treasury yields and inflation-protected bonds of the same duration, rose to levels not seen in more than two years.

The “breakeven” rate for 10-year inflation expectations briefly touched 2%, a level that policymakers consider healthy but also was indicative of a market that already is looking for pressure while the Fed’s favorite indicator is closer to 1.4%.

Central bank officials have said they will tolerate levels higher than 2% in an effort to gin up expectations, rev the economy and get back to full employment. But if inflation rises faster than expected, that could be toxic for investors as it would force the Fed to tighten policy sooner than officials would like.

“They’re purposely inflating a bubble and then rooting for the exact thing that pops it,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “There’s this idea that central banks are constantly in control of things. If there’s one thing that will change that, it’s the kryptonite of higher inflation.”

Indeed, some market participants are starting to worry that with stock valuations reaching generational highs and the Fed so far not sharing any bubble concerns, the market could be in for a reckoning.

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Reuters/Asha Sistla
Gold begins 2021 with 2% jump as dollar falters

Gold began the new year by climbing 2% on Monday, closing in on its highest in nearly two months as the dollar slid to 2018 lows and prospects of tougher restrictions to combat a new variant of the coronavirus kept safe-haven bullion in demand.

Spot gold was up 1.7% at $1,930.20 an ounce by 1255 GMT, having risen as much as 2% to its highest since Nov. 9 at $1,936.31. U.S. gold futures advanced by 2.1% to $1,935.60.

“Since gold reversed course from below $1,900, this is mainly a reflection of a weaker U.S. dollar … a very fertile backdrop for gold and based on that we’ve also seen some trend followers and technical traders coming back into the market, extending this rally,” said Julius Baer analyst Carsten Menke.

Although potentially stricter curbs in Britain and Japan have not dampened risk appetite, bullion remains supported by the clampdowns, Menke added.

The dollar index tumbled to a 2-1/2 year low, making gold cheaper for other currency holders.

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Kitco/Anna Golubova
‘$2,300 is gold’s key level’: Georgia Senate runoffs, bitcoin crash to boost prices to new highs – OANDA

The new year will bring in more uncertainty, and gold prices will thrive on more stimulus, inflation risk, and bitcoin’s bubble bursting, according to OANDA senior market analyst Edward Moya.

“2021 is going to be a very strong year for gold. I am very bullish. $2,300 will be a key level,” Moya told Kitco News in December. “This pandemic has done tremendous economic scarring to the U.S., and what you are probably going to see is unprecedented fiscal and monetary stimulus continue in the first half of the year.”

The economic recovery is likely to be unbalanced and will take longer-than-expected. In light of this, the Federal Reserve will remain accommodative and will be one of the last central banks to start hiking rates, which will kick in reflation trade and boost gold to new highs.

“You are not going to see the economy completely restored until at some point late in 2022, and the Fed is not going to be in a position to raise rates until then. This is why gold will have an easy time,” Moya said. “The next six months are still going to be really tough. The vaccines are not going to be as successfully distributed as people are anticipating.”

It is not out of the question that the Fed could adopt yield curve control over the next few months and provide more accommodation because of the problems in the labor market. By the end of 2021, the U.S. is still likely to have at least five million people unemployed and reliant on benefits, Moya pointed out.

“Gold will benefit because we will have a cautious Biden administration that will provide more aid and support longer lockdowns. This will drive the gold trade in the first half of the year,” he said. “That is going to be the main reason why gold will make a strong run towards $2,300. This goes regardless of how things unfold on the vaccine rollouts.”

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Yahoo Finance/Ines Ferre
Georgia runoff results could trigger a 10% stock market selloff: Strategist

Investors will have their eyes peeled on the Georgia run-off elections on Tuesday to determine which party will control the Senate. A Democratic win of the two contested Senate seats could trigger a selloff in the markets, according to Oppenheimer strategist John Stoltzfus.

“Should the Democrats win both seats, we expect the S&P 500 to become vulnerable to a downdraft in the neighborhood of 6% to 10%,” wrote Stoltzfus in a note to investors.

“In our experience the markets prefer that Washington’s Capitol Hill have enough checks and balances in place to keep political power out of just one party’s hands,” he added.

The Democrats already control the House of Representatives. A Democratic Senate sweep “would bode ill for business with the likelihood that corporate tax rates could rise substantially,” added Stolzfus.

“In addition, a Democratic sweep in Georgia would likely see a boost in new government program creation and spending at a time when many voters, market participants and business leaders are concerned about the sizable level of debt that the Treasury has had to take on to provide a financial ‘bridge over troubled water’ via fiscal stimulus,” he added.

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