Low Inflation Makes Powell a Dove. How It Affects Gold? / Commodities / Gold & Silver 2020

Inflationremains low, while Powell signals dovish Fed for years. Good for gold.

The US CPI inflation ratedeclined 0.1 percent in May, following a0.8 percent drop in April. The decrease was mainly driven by decreases in energy,transportation and apparel prices. The core CPI also declined 0.1 percent, following a 0.4percent drop in April. It was the third consecutive monthly decline, whichhappened for the first time in history of the index that starts in 1957.Anyway, compared with the previous month, we see some stabilization of disinflationforces, at least on a monthly basis.

On annualbasis, the overall CPI increased just0.2 percent (seasonally adjusted and merely 0.1 percent without theseasonal adjustments), following 0.4 percent increase in April. It was thesmallest 12-month increase since October 2015. The core CPI rose 1.2 percentover the last 12 months, compared to the 1.4 percent increase in the previousmonth. It was the smallest increase since March 2011. Both indices aresubstantially lower than a few months ago. The chart below shows these disinflationary trends.

The softening inflation could theoretically reduce thedemand for inflationary hedges, but it alsomeans that the Fed will remain dovish for years, which shouldsupport gold prices overall.  

Powell’sPress Conference and Gold

In last edition of the Fundamental Gold Report, I mentioned the lastPowell’s press conference, but I would like to point out a few more things.First, he said that the Fed is considering to target the yield curve, similarly to the Bank of Japan. If adopted, suchpolicy should imply ultra low interest rates for longer,supporting the gold prices. 

Second, Powell signaled also that the interest rates will remain low atleast until the unemployment rate will not returnto normal:

So, I think we have to be humble about our abilityto move inflation up, and particularly when unemployment is -- is going to beabove most estimates of the natural rate for -- certainly above the median inour -- in our -- in our SEP, well through the end of -- past the end of 2022.

It means that even if inflation goes up, the Fed will not react in a hawkish manner as long as unemploymentrate is below the natural rate of unemployment. Given that inflation hasrecently declined, the Fed’s dovish bias is almost certain. And what isimportant here is that Powell expects a significant slack in the labor market. Inother words, the coronavirus crisis will lead to permanent job losses:

My assumption is that there will be a significantchunk -- chunk, well into the millions. I -- I don't want to give you a numberbecause it's going to be a guess, but well, well into the millions of peoplewho -- who don't get to go back to their old job and in fact, there isn't a --there may not be a job in that industry for them for some time. There willeventually be, but it could be some years before we get back to those people findingjobs

Third, Powell is worried about the second wave of coronavirus cases. Hebelieves that it might be another factor behind the gradual recovery, notnecessarily a V-shaped one:

I think, that if a -- if it happens -- you know, the-- the issue would be, first of all, people's health, but secondly, you couldsee a public loss of confidence in -- in parts of the economy that will bealready slow to recover, so it could hurt the recovery, even if you don't havea national level pandemic, just a -- just a series of -- of local ones -- oflocal spikes could -- could have the effect of undermining people's confidencein traveling, in restaurants, and entertainment, anything that involves gettingpeople together in small groups, and feeding them, or flying them around, thosethings could be hurt. So, it would not be a positive development, and I'll justleave it at that.

And Powell might be right. As the chart below shows, the number of theUS daily cases have been rising recently, probably due to massive riots onAmerican streets.

Implicationsfor Gold

What does it all mean for the gold market? The recent Powell’s pressconference indicating that there is still a long way to recovery was a coldwater for many stock market investors (but not for our Readers, as we have beenwarning for many weeks that the investors’ optimism about the V-shaped recoverymay be not really founded in reality). People also started to worry that newvirus infections could stunt the pace of the economic recovery. In consequence,both the Dow Jones and S&P 500 indexes sufferedtheir biggest weekly percentage declines since March. The weaker riskappetite should be positive for safe-haven assets such as gold. Moreover,lower inflation with uncertain recovery imply a dovish Fed and the ZIRP to stay with us for years, which – fromthe fundamental point of view – should also support the gold prices.

Thank you.

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Arkadiusz Sieron

Sunshine Profits‘ MarketOverview Editor

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