The gold market considered recent Powell remarks as dovish. And the market is always right, isn’t it? Here’s some insight…
The gold market considered recent Powell remarks as dovish. And the market is always right, isn’t it?
Just Below Neutral
On Wednesday,delivered a speech at The Economic Club of New York. The majority of analysts judged the speech as . Why? The key reason was Powell’s view that interest rates were close to neutral:
Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy – that is, neither speeding up nor slowing down growth.
And indeed, it looks like an important change since last month, when Powell believed that thewas far from neutral level. On October 3rd, in a question-and-answer session with Judy Woodruff of PBS, the Fed Chair said:
Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral. We may go past neutral, but we’re a long way from neutral at this point, probably.
However, the analysts omit less dovish parts from Powell’ speech. First of all, the Fed Chair started his speech noting that the U.S. has almost fulfilled the goals of maximum employment and price stability:
Congress assigned the Federal Reserve the job of promoting maximum employment and price stability. I am pleased to say that our economy is now close to both of those objectives. The unemployment rate is 3.7 percent, a 49-year low, and many other measures of labor market strength are at or near historic bests. Inflation is near our 2 percent target. The economy is growing at an annual rate of about 3 percent, well above most estimates of its longer-run trend.
Let’s make it clear: with the unemployment rate at a 49-year low,above 2-percent target, and growth above the potential, the federal funds rate at merely 2.2. percent is definitely not close to the neutral level. Just look at chart below which paints the policy rate over time. are ultra low by historical standards.
Chart 1: Effective Federal Funds Rate between 1955 and 2018.
And Powell knows that. He just wanted to calm investors after the recentvolatility. It suggests that the gains in gold might be temporary.
Vulnerabilities at a Moderate Level
Moreover, Powell was optimistic about the risk balance of the US economy. The major part of his speech was the discussion of the newthat the published earlier on Wednesday. Powell concluded that although he noted some growing risks to the US economy, he did not see significant warning signals:
My own assessment is that, while risks are above normal in some areas and below normal in others, overall financial stability vulnerabilities are at a moderate level.
And we will see similar conclusions when we dig into the report. Although corporate debt is high, while asset valuations are elevated, the risks of destabilizing runs are far lower than in the past, while the key financial institutions are more resilient. It’s not good news for gold.
Implications for Gold
As one can see in the chart below, the gold market agreed with the market analysts and judged Powell’s speech as dovish. The price of the yellow metal jumped yesterday above the $1,200, which indicates that gold welcomed the Fed Chair’s remarks.
Chart 2: Gold prices between November 26 and November 28, 2018.
However, the Fed does not see neither a broad-based buildup of abnormal leverage, nor dangerous excesses in the stock market. Therefore, it should continue its policy of gradual. The next hike is still coming in December. And a few more next year. So, should not open the champagne too early. But who knows: today, the will publish the minutes of its last meeting and we could learn more about the mindset of the Fed officials. Stay tuned!
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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.
Arkadiusz Sieron, Ph.D.
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