The Fed Needs To Slow Down; Look For Gold To Benefit - Sprott Asset Management
(Kitco News)- The U.S. Federal Reserve is likely to scale back its plannedrate hikes by yearend, providing a powerful tailwind for gold, according to arecent report from Sprott Asset Management.
“Fed policy reversal would be the final component of apotent combination of fundamentals which has been developing in gold’s favorduring the past several quarters,” the report said.
The Fed initiated its monetary policy tightening in December2015, and since then has raised the fed funds rate six times to 1.75%.
Concurrently, the world’s largest central bank has embarkedon a process of reducing its $4.5 trillion post-quantitative easing balancesheet by gradually scaling back Treasury and mortgage-backed security holdingsby $10 billion a month starting in fourth quarter 2017, up to a monthly peak of$50 billion per month by fourth quarter 2018.
Analysts at Sprott said that pursuing this dual mandatesimultaneously poses a risk of causing severe harm to the markets.
“We are skeptical the Fed can continue the simultaneouspursuit of its policy goals without inflicting significant damage on U.S.financial markets,” the report said.
Sprott added that the “liquidity destroying implications ofthe Fed’s proposed quantitative tightening (QT) schedule are almost completelybeing ignored by consensus.”
According to the report, the two-pronged monetary tighteningstrategy of hiking rates while reducing the Fed’s balance sheet is overly-aggressive.Citing Chairman Bernanke, Sprott said that every $200 billion in reductions inthe Fed’s balance sheet are already equivalent to a 25-basis point rate hike.
“We do not believe outstanding debt levels in the U.S.financial system can withstand this type of blunt force monetary tightening,especially in concert with the FOMC’s telegraphed schedule of fed-fund hikes,”the report said.
Evidence of an already strained global financial systemcomes in the widening LIBOR-OIS spread in first quarter 2018, the firm said.
The LIBOR-OIS spread measures the premium of 3-month LIBORto the fed funds rate. While the spread usually hovers around ten basis pointsin “normal” market conditions, it can widen when U.S. dollar liquidity ischallenged, or banks perceive heightened peer-lending risks.
The current LIBOR-OIS spread is at its highest level sincethe 2008 recession. “In retrospect, the spread’s initial spike above 50 basispoints in August 2007 proved to be a prescient warning for mounting financialstress,” the report said.
By David Lin
For Kitco News
Follow @davidlinMTL
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