The Fed gone all hawkish and brushed off the latest weak inflation data in its decision in the previous week. Despite the rhetoric, the markets haven’t budged and still estimate less than 50% chance of another hike by the end of the year. Gold and silver prices took a hit last week even though long term interest rates dropped on account of the slower pace of U.S. inflation. Moving forward, what does this Fed decision mean for bullion?
The FOMC, as expected, raised rates by 25 basis points to 1%-1.25%. And the FOMC, for the first time, also presented a detailed plan to reduce the balance sheet without a starting point. Based on this plan the FOMC will let treasury and mortgage backed securities expire at a growing scale from $10 billion a month to $50 billion. This will come to $340 billion within the first year or roughly 7.5% of the current size of the balance sheet. The market expects the FOMC to kick off this normalization in September.
Following the news about the FOMC interest rates rallied a bit even though they ended the week down mainly after the weak inflation data (the decline in retail sales also didn’t help). Alas, this fall in yields didn’t boost demand for gold and silver as their prices declined last week.
The hawkish tone of the FOMC in the statement, its economic outlook, dot plot and Yellen’s comments in the press conference all led down bullion prices. But this may not last long if the recent trend in the market of falling interest rates were to persist. After all, equities in the U.S. are also starting to feel pressure, which may eventually lead to a risk off sentiment that may also boost back the demand for bullion.
More importantly there is the disconnect between the market and the FOMC: The FOMC – which has been consistent in its view to be “data dependent” – made a decision to raise rates and still consider the drop-in inflation growth as transitory. And while Q2 is still expected to be better – in terms of growth – than Q1, the markets are becoming more concerned of the state of the economy due to hard data that show slowdown. The FOMC used to follow the data: In the past when inflation started to dip, the FOMC would hold off from raising rates and wait to see data showing a return of the upward trend. But this time was different. The Fed’s rational behind raising rates is likely to include the following factors:
- The FOMC is trying to raise rates above the near zero levels;
- avoid a situation of raising rates fast in case of a sudden eruption of inflation – that could tip the economy to a recession;
- use this opportunity to deflate the high valuations in the stock market;
- And the soft data are still relatively strong – GDP now expect Q2 to rise by 2.9% (although, it was revised down from over 4% at the beginning of the quarter.
Despite these reasons the risk isn’t symmetric and skewed more towards lower inflation problems rather than higher.
Gold and silver didn’t perform well after Fed week but this could all change if the FOMC’s decision were to put more pressure on equites that could revive a risk off sentiment. Conversely, so far the hawkish tone of the FOMC had limited impact on long term interest rates and the USD. If this trend were to persist and the economic data were to keep coming below market estimates, precious metals will benefit from this trend.
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