Patient Approach Remains Appropriate for Fed. How Will Gold React? / Commodities / Gold & Silver 2019

The Fed released the minutes from its last meeting. What arethe Fed’s views on the economy, global risks and inflation? What do thelearnings imply for the US monetary policy and in turn, the gold market?

Minutes Show That FOMC Members AreStill Patient

The minutes from the May FOMC meetingshow that the Fed is stillpatient. The downside risks for the global economy diminished and the financialconditions improved. As a result, the UScentral bank decided to keep its patient approach to the monetary policy in place:

In light ofglobal economic and financial developments as well as muted inflationpressures, participants generally agreed that a patient approach to determiningfuture adjustments to the target range for the federal funds rate remainedappropriate. Participants noted that even if global economic and financialconditions continued to improve, a patient approach would likely remainwarranted, especially in an environment of continued moderate economic growthand muted inflation pressures.

Perhaps thisis why the gold market saw little reaction to the minutes, as thechart below shows. After all, they did not contain any significant surprises.The fact that the Fed is in no hurry to adjust monetary policy one way or theother was widely expected and already factored into the gold prices.

Chart 1: Gold prices from May 21 to May 23, 2019.

 
But does it meanthat the publication is irrelevant? Not necessarily! We learned manyinteresting things about the FOMC members’ views. First,             thepolicymakers are more upbeat regarding the balance of risks for the globaleconomy. Although they agreed that downside risks to theoutlook for growth remain, some participants “viewed risks to the downside forreal GDP growth as having decreased, partly because prospects for a sharpslowdown in global economic growth, particularly in China and Europe, haddiminished”.

Moreover, a number of participants noted that“financial market conditions had improved following the period of stressobserved over the fourth quarter of last year and that the volatility in pricesand financial conditions had subsided.” What is important here is that theimprovement in financial conditions was regarded by many participants asproviding support for the outlook for economic growth and employment. The more optimistic outlook shouldtranslate into more hawkish Fed in the future – and exert downward pressure ongold prices. There’ s one caveat here, however. The renewed trade wars may preventthe US central bank from abandoning its patient approach.

Second, the Committee members agreed that the recentdip in inflation was likelyto be transitory. As long as inflation stays near or below the 2-percenttarget, the Fed sees no reason to change the federal funds rate in one way oranother. However, if the subdued inflationary pressure is transitory, it canreemerge in the future. And then, the US central bank would need to tighten itsmonetary stance:

Manyparticipants viewed the recent dip in PCE inflation as likely to be transitory,and participants generally anticipated that a patient approach to policyadjustments was likely to be consistent with sustained expansion of economicactivity, strong labor market conditions, and inflation near the Committee'ssymmetric 2 percent objective (…) However, a few participants noted that if theeconomy evolved as they expected, the Committee would likely need to firm thestance of monetary policy to sustain the economic expansion and keep inflationat levels consistent with the Committee's objective, or that the Committeewould need to be attentive to the possibility that inflation pressures couldbuild quickly in an environment of tight resource utilization.

This is really important. The Fed believes that the recent softness in inflation have been causedby such distinctive (idiosyncratic) factors as unusually sharp declines inthe prices of apparel and of portfolio management services:

At leastpart of the recent softness in inflation could be attributed to idiosyncraticfactors that seemed likely to have only transitory effects on inflation (…)Some research suggests that idiosyncratic factors that largely affectedacylical sectors in the economy had accounted for a substantial portion of thefluctuations in inflation over the past couple of years.

Indeed, the trimmed mean measure of PCE priceindex, which removes the influence ofunusually large changes in the prices of individual items in either direction, had been stable at or close to 2 percentover recent months, as one can see in the chart below.

Chart 2: PCE Price Index (green line, % change fromyear ago) and trimmed mean PCE Price Index (red line, % change from year ago)from March 2014 to March 2019.

If true, we should see a rebound in inflation in thefuture. It means that the Fed may turn more hawkish in thefuture, or at least that the cut in interestrates is less likely that the marketsexpect. This is not good news for the gold bulls.

Implicationsfor Gold

What does it all imply for the gold market? Well, thelatest FOMC minutes confirm that the US central bank will remain patient for awhile. The pause in tightening shouldsupport the gold prices. However, the market expectations of the interestrate cut later this year might be inappropriate. The minutes show that theCommittee members are more optimistic about the balance of risks and thebehavior of inflation in the medium term. The recent softness is believed to becaused by transitory factors to a large extent. This is what the trimmed PCEPrice Index also suggests. Hence, inflation should go up later in the future. If the Fed lags behind the curve, goldwould benefit. But if higher inflation prompts the FOMC members to tightenits monetary policy stance, and if the expected interest rate path shifthigher, the yellow metal may struggle,then.

Thank you.

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Arkadiusz Sieron

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