Fed Slashes Rates to Zero and Introduces QE in Response to COVID-19. Will Gold Rally Now? / Commodities / Gold & Silver 2020

On Sunday, the Federal Reserve cut interest rates andrestarted quantitative easing to stimulate economy hit by the pandemic ofCOVID-19. That’s already its second move prior to this Wednesday’s FOMC. Whatdoes it imply for gold?

It’s Serious, Really.

Winter is not coming. Winter ishere already. The situation does not look too good. Although the epidemic seemson the way out in China and South Korea, the situation in Europe and the US isdeteriorating quickly. As you can see in the charts below, the new daily casesare quickly rising, making the totalnumber of infected people doubling each 3-4 days. And please note that thechart shows only confirmed cases – the true number of infected people is almostcertainly larger, especially in the US, where shockingly low number of testshave been conducted.

Chart 1: Daily new confirmedcases of COVID-19 in the US from January to March 14, 2020

 
Chart 2: Daily new confirmedcases of COVID-19 in Italy (red line) and Spain (blue line) from February toMarch 15, 2020:

Before I go on and analyze Fed’sactions, I have to admit to while I was always concerned by the currentepidemic as it leaped outside of China, Iunderestimated its health and economic impact. Surely, I’m not anepidemiologist and I wasn’t the only one (think about the Italians, the WhiteHouse or Spanish PMs’ wife), but I should be smarter than the governments. It’sof little comfort that the whole world and markets overlooked the danger for somany weeks, and we’re all paying the price now.

One reason is that media arealways panicking. Fear sells. They cry a wolf all the time, and when the truewolf comes, no one believes the boy that cried wolf too many times. Secondreason was that when I analyzed the previous pandemics, such as SARS, MERS, orEbola, they all were short-lived and their health and economic impact waslimited. But, as I already suggested this likelihood, in one of the previouseditions of the Fundamental Gold Report, thistime is really different.

Why it is different? Well, it isbecause the new coronavirus is really smart. You see, Ebola was a stupid virus.It was very lethal, but it killed its hosts so quickly that it could not bewith such ease transmitted to the others. MERS was not easily transmitted amongpeople. And SARS was quickly contained because people transmitted the virusonly well after they had symptoms. So, the authorities could easily track theinfected people and isolate them. Problem solved. But the new coronavirus has adeadly combination of features. It is less lethal now than it was initially, andis more contagious. And people cantransmit it before they have any symptoms. They can even have no symptomsat all!
 
All this means that containmentis practically impossible. And comes with bringing the economic activity to astandstill. A very heavy price to pay. Let’s face it. A high percentage ofworld’s population will be infected. And many will die. We do not panic, butthis is a fact. What we can done is to break its exponential trajectory, mitigateits impact and flatten the epidemiological curve, as the chart below shows.

Chart 3: The idea of flatteningthe curve.

In this way, we can slow the rateof infection to prevent the healthcare system from the total collapse. The goodthing is that the mortality rate isgenerally low, especially among children and the young and healthy. But theproblem is there are many people with health issues. A great percentage ofAmericans are obese and not too few are smoking – which worsens theirsituation. All this means that it’s probable that the pandemic will not be ashort-term issue we can quickly deal with, but that it will stay with us formonths (I recommend this podcast withMicheal Osterholm, expert in infectious disease epidemiology, especially the first fifteen minutes)…

Ok, What Did the Fed Do?

On Sundayemergency meeting, the Fed slashedthe federal funds rate to zero,or to almost zero, to be precise:

Consistentwith its statutory mandate, the Committee seeks to foster maximum employmentand price stability. The effects of the coronavirus will weigh on economicactivity in the near term and pose risks to the economic outlook. In light ofthese developments, the Committeedecided to lower the target range for the federal funds rate to 0 to 1/4percent. The Committee expects to maintain this target range until it isconfident that the economy has weathered recent events and is on track toachieve its maximum employment and price stability goals. This action will helpsupport economic activity, strong labor market conditions, and inflationreturning to the Committee's symmetric 2 percent objective.

Moreover, the US central bank hasexpanded its repo operations and reintroduced the quantitative easing:

The FederalReserve is prepared to use its full range of tools to support the flow ofcredit to households and businesses and thereby promote its maximum employmentand price stability goals. To support the smooth functioning of markets forTreasury securities and agency mortgage-backed securities that are central tothe flow of credit to households and businesses, over coming months theCommittee will increase its holdings of Treasury securities by at least $500billion and its holdings of agency mortgage-backed securities by at least $200billion. The Committee will also reinvest all principal payments from theFederal Reserve's holdings of agency debt and agency mortgage-backed securitiesin agency mortgage-backed securities. In addition, the Open Market Desk hasrecently expanded its overnight and term repurchase agreement operations. TheCommittee will continue to closely monitor market conditions and is prepared toadjust its plans as appropriate.

Will these actions help the economy? Now, they won’t. Has the Fed’s first cuthelped to prevent the COVID-19 spread? No, it has not. If an entrepreneur cannot obtain the inputs badly needed for his factory,or if employees do not appear at work, the level of interest rates does not matter. Neither Powell, nor Lagarde, nor any other central bankers haveany power to open production and service facilities closed due to quarantine or to push employees back to work, and consumers back to stores, cinemas, pubsand travel agencies.

Anyway, let’s assume that theproblem is related to the demand, not to the supply (as politicians and centralbankers will probably argue). How shouldinterest rate cuts help if people are encouraged to stay at home and,therefore, reduce economic activities? Which companies will start investingmore in a period of reduced demand, supply chain disruptions, falling stockprices, and increased uncertainty in general?

Since ultra low interest ratesdid not help to revive exceptionally weak economic growth after the Great Recession, it will not helpmuch now. Coronavirus affects the economy mainly by changing people’s behavior –the  actions of central banks will notchange them. We deal with the healthcarecrisis, not the liquidity crisis – so the extra liquidity will not help.

Implications for Gold

What does it all mean for thegold market? Well, panicked central banks reintroducing quantitative easing and ZIRP, combined with great fear and plungingstock markets, are fundamentallypositive for the gold prices.

If so, why the heck the goldprice has declined today below $1,500? That’s a good question. As I saidpreviously, cash is king in times of crisis. Investors desperately sell everythingto raise cash to meet their margin calls. Wesee a replay from 2008 financial crisis, when thegold prices initially fell – but started to rally after a while. The epidemiology ofCOVID-19 suggest that this crisis will be larger than almost everyone initiallythought. And the fact that the Fed acted in a panic mode just three daysbefore the scheduled meeting suggests that we can expect really horrible datain the next few weeks. So, I think that the path of least resistance for gold is to rise in themedium term – the only question is when it will happen. 

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Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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