Hawks, Doves and Gold

There is a split on interest rates among the Fed officials. What does it mean for the gold market?

Yesterday, we covered the contradictory comments of Rosengren and Brainard about the economic outlook and interest rate hike prospects, and how their remarks influenced the intra-day price movement of gold. Let’s now dig into their speeches to analyze the arguments of both hawks and doves. Why does Rosengren want to hike?

• The resilience of the U.S. economy, despite the headwinds from the abroad: “Over the past year the United States economy had remained fairly resilient despite the economic ‘drag’ emanating from overseas”.
• The tightening of the labor market and the upward outlook for inflation: “Labor markets in the U.S. continue to gradually tighten, and inflation is slowly returning to the Federal Reserve’s 2 percent inflation target. In fact, it is quite possible that we will reach or even exceed full employment over the course of the next year.”
• The risk of an overheated economy, which would pose risks to maintaining full employment over time. There is a difficulty of “slowing the economy to a sustainable rate without going too far and causing a recession”.
• The risk that “some asset markets become too ebullient”. Rosengren pointed out that real commercial real estate prices have risen quite rapidly over the past five years, particularly for multifamily properties.

What is the answer of Brainard? She generally argued that there is a ‘new normal’ in economic conditions which requires a new, more prudent, approach to monetary policy. In particular, she pointed out that:

• Inflation has been undershooting, and the Phillips curve has flattened. It implies that the tightening of the labor market does not need to translate into higher inflation.
• The labor market slack has been greater than anticipated. There is still some room to go. For example, the share of employees working part time for economic reasons has remained noticeably above its pre-crisis level. Therefore, the case to tighten policy is less compelling.
• The foreign markets matter, especially because financial transmission is strong. There are many headwinds from abroad, which should not be neglected as global financial markets are tightly integrated and disturbances from other major economies quickly spill over to U.S. financial markets.
• The neutral interest rate is likely to remain very low for some time. Therefore, “it may require a relatively more modest adjustment in the policy rate to return to neutral over time than previously anticipated”.
• Policy options are asymmetric. Hence, from a risk-management perspective, the monetary policy should “be tilted somewhat in favor of guarding against downside risks relative to preemptively raising rates to guard against upside risks”.

We will not be original, but both sides have a point. We are inclined more to Rosengren’s views, as historically the Fed – busy chattering about ‘new normal’ and other nonsense – has typically neglected the risk of asset bubbles. The Great Crisis, the dot-com bubble, the housing bubble and the Great Recession – oh, the list goes on. But our opinion is irrelevant for the gold market – what really counts is what the Fed will do in September. On the one hand, the hike is unlikely, given the panicky market reactions to Rosengren’s hawkish comments. On the other hand, there may be a slight shift in the balance of power among the FOMC. You see, Brainard was always considered as one of the most dovish members, therefore her remarks are not a surprise. However, Rosengren also used to be considered a dove, so his hawkish arguments may be a thing.

Given the current low market odds of a move this month, the hike would be a surprise, which could push the price of gold down. Conversely, inaction should be positive for the gold market. However, investors should remember that a lot also depends on the forward guidance provided at the FOMC meeting. The last interest rate hike in December 2015 was generally bullish for gold as the move was accompanied by a dovish message regarding future policy.

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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.

Thank you.

Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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