Will the Fed Keep Its Pledge of Low Rate until 2014?

The FOMC pledged a couple of months back to keep the currently low interest rates at least until late 2014. Will the Fed keep its pledge at all cost? What might trigger the Fed to flip-flop on its pledge and raise the interest rate before 2014? And finally what will this unlikely scenario do to the price of gold? 

First, I would like to stress that I don’t think it is likely the Fed will go back on its pledge, but I do think there are certain unlikely and yet still possible scenarios in which the FOMC may decide to change direction and raise interest rates. One of these scenarios is a sharp rise in the U.S. inflation. Before dwelling on this issue let’s put some context to the Fed’s monetary policy and its effect on precious metals prices:

The Fed pledged back in August 2011 to keep rates low at least until mid 2013, and then raised the ante by pushing its pledge further up to late 2014.  In both cases gold and silver prices reacted very promptly and sharply rose. Many had anticipated based on these statements that the Fed will eventually introduce another quantitative easing plan.

The Fed referred in its recent FOMC statement from last week to the economic progress of the U.S. mainly the labor market; the recent non-farm employment report surely backs up this claim. This statement lowered the chances of another QE program by the Fed. The next day gold and silver prices tumbled down. I have already referred in the past how the QE programs positively affected the price of precious metals. Another key factor is the very low interest rates that help pull up not only the U.S stock market, but also gold and silver prices.

On Friday, March 16th the February 2012 U.S consumer price index was published. According to the report the US core CPI (sans energy and food) rose by 2.2% in the past year (up to February 2012). This is slightly higher than the Fed would have wanted but not terrible.

One of the main components of the core CPI is related to the housing market which is still struggling. This means we are less likely to see a sharp rise in US inflation within the next two years but not impossible especially if the U.S housing market will start to heat up again.

If the core CPI will continue to rise, it could pose a problem to the Fed. At such an unlikely event, the Fed may need to pull out of its monetary plan and raise interest rates before late 2014. Some speculate that the Fed will raise rates within 2013.

In such a scenario I speculate the price of both metals – gold and silver will tumble down because the U.S dollar will appreciate immediately against major currencies, and the “safe haven” investments will have a return once again.

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