Inflation would have to soar to force the Fed to increase the federal funds rate…
Yesterday, that was already the third time this year when the Fed cut interest rates. In response, the price of gold erased earlier losses. That sounds a bit fishy. What is going on?
Fed Lowers Interest Rates by 25 Basis Points
Yesterday, the FOMC published the monetary policy statement from its latest meeting that took place on October 29-30th. In line with expectations, the U.S. central bank cut the federal funds rate by 25 basis points, for the third time in 2019 already:
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-1/2 to 1-3/4 percent.
Just as previous times, the decision was considered to be an insurance against ongoing risks. But not all Committee members were convinced that the U.S. economy needed such an insurance. Esther L. George and Eric S. Rosengren wanted to maintain the interest rates unchanged. It suggests an important internal opposition to further cuts in interest rates.
No More Cuts. For Now…
Indeed, it seems that the Fed has exhausted its potential for further interest rate cuts in the near future. This is what the U.S. central bankers signaled in the statement. In September, they wrote:
As the Committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.
But this time, they removed the phrase “act as appropriate” to sustain the expansion, which had been used to signal further monetary easing.
The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate.
The changed statement is more hawkish and indicates that the FOMC has completed a “mid-cycle” rate adjustments yesterday. Hence, the Fed implied not to expect more cuts for now. This is bad news for the gold market. And indeed, the price of the yellow metal has initially plunged, as the chart below shows. But it quickly rebounded.
Chart 1: Gold prices from October 29 to October 31, 2019.
Implications for Gold
Gold reversed its downward course thanks to Powell. You see, the Fed Chair excluded the next hikes for some time. He said that inflation would have to soar to force the Fed to increase the federal funds rate:
We are not thinking about raising rates right now (…) I think we would need to see a really significant move up in inflation that is persistent before we would consider raising rates to address inflation.
This is great news for the gold bulls, as it means that the Fed will not exert any downward pressure on the gold market in the near future. The U.S. central banks sees its monetary policy as neutral now, so it will not change its course. At least, we do not expect any moves in December.
Of course, the Fed’s ‘wait and see’ mode also means no further cuts in interest rates and no upward pressure on the bullion. But don’t be deceived! The history of the Fed clearly shows that it has a dovish bias. If the economy slows down next year, which is not unlikely given the inversion of the yield curve and the slowdown in the industrial sector and business investments, the U.S. central bank will ease its monetary policy further. For the benefit of gold.
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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.