Fed’s Vulnerability is Gold’s Strength

We discuss the Federal Reserve often because the more the Fed tries to ‘undo’ its past policy mistakes and alters the markets through its poor policies, the more gold and silver prices are likely to rise! Yesterday’s meeting is an example: the more the Fed Chairman spoke the more the metals prices rose.

As largely expected, the Federal Reserve increased the Fed funds rate an additional 25 basis points to a range of 5.00% to 5.25%. The overriding message was “we will now wait-and-see”. 

The main change in the statement from the March meeting statement was the removal of the sentence: The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. 

And replaced it with: In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments (bolding added).

3 Reasons Why Patrick Karim is Bullish on Gold

In the press conference Powell then explained that this change means that they no longer anticipate that rate hikes will take place at future meetings but instead will be driven by incoming data meeting by meeting. Hence, the wait-and-see message. 

Vulnerabilities exposed

This week’s increase was the 10^th increase in the fed funds rate since March 2022 for a total increase of 5% in just over a year. Inflation, although down from 2022 highs, still remains well above the Fed’s 2% target, but the rapid increases are exposing vulnerabilities in the economy, especially in the financial sector. 

Chair Powell started his press conference by addressing the continuing problems in the banking sector saying: conditions in [the banking] sector have broadly improved since early March, and the U.S banking system is sound and resilient. We will continue to monitor conditions in this sector. We are committed to learning the right lessons from this episode and will work to prevent events like these from happening again.

Contrasting opinions

Although the Fed, FDIC and U.S. Treasury have made implicit guarantees of banks and the financial sector, markets don’t seem to agree that conditions have broadly improved, the Dow Jones Regional Banking Sector Index declined further on Wednesday. And gold and silver rallied further with gold on the verge of setting a new all-time high. (For more on the vulnerabilities lingering problems in the banking sector see our post Has the IMF Told the World to Buy Gold? from April 13th) 

The effects of the rapid increases are not only in the financial sector, but other interest rate sensitive sectors are also weakening, such as the housing, commercial real estate and investment sectors. 

Chair Powell addressed these vulnerabilities: Credit conditions had already been tightening over the past year or so in response to our policy actions and a softer economic outlook. But the strains that emerged in the banking sector in early March appear to be resulting in even tighter credit conditions for households and businesses.

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In turn, these tighter credit conditions are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. In light of these uncertain headwinds, along with the monetary policy restraint we have put in place, our future policy actions will depend on how events unfold.

As for the future path for monetary policy Powell stated: We will make that determination meeting by meeting, based on the totality of incoming data and their implications for the outlook for economic activity and inflation. And we are prepared to do more if greater monetary policy restraint is warranted.

Recession incoming: standby gold and silver

The yield curve and leading indicator continue to point to recession later this year. It is likely that the next Fed interest rate move will be easing later this year to support the economy and the banking sector. Inflation is likely to continue to rollover somewhat, but stay higher than pre-Covid levels due to changing policies – see our post from October 7 The Inflation Tide is Turning! Although Chair Powell continues to say that the Fed’s goal is inflation back to 2% growth – he always adds …. Over time, which could mean that inflation won’t return to 2% anytime soon. 

Bottom Line: Equity markets are still trying to figure out how to read central banks – but gold and silver are the smart ‘out of the fiat currency’ alternatives rising as the vulnerabilities from rapid rate hikes continue to unfold … and more are to be exposed.  

From The Trading Desk

Market Update:

Gold has moved out of its tight trading range and is now within 2% of its all-time high this morning.

This has come on the back of the US interest rate hike yesterday, bringing US rates to a 16-year high to combat soaring inflation that hit a 40-year high.

The quarter-point rate hike was expected but what the gold market was looking for, is the rate hike cycle nearly done.

At the press conference after the rate announcement we got more clarity, Powell said “There is a sense that, you know, we’re much close to the end of this than to the beginning.”

The regional bank collapse contagion is still spreading, the First Republic did not make it through the weekend and attention has now moved to PacWest Bankcorp whose share price has fallen over 30% in the last 2 days. The spotlight also is on another regional bank, Western Alliance. 

Stock Update 

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