Yesterday, the minutes of the Federal Reserve’s March meeting were released. What do they say about the Fed’s stance and what do they mean for the gold market?
How can we summarize the recent FOMC minutes? First, the FOMC members agreed that the labor market had continued to strengthen and that economic activity had continued to expand at a moderate pace, while inflation had increased in recent quarters and moved close to the Committee's 2 percent longer-run objective, but core inflation was little changed and had continued to run somewhat below 2 percent. In other words, although the headline inflation hit the target, it did not reach it on a sustained basis. Don’t ask how the Fed defines “a sustained basis”. It means that the Fed may be behind the curve, which should be positive for the yellow metal, as rising inflation not appropriately counteracted by Fed hikes lowers real interest rates. As we already know, these developments led the FOMC members (with one dissenting vote) to raise the target range for the federal funds rate to 3/4 to 1 percent.
The new thing in the recent minutes was a discussion about balance sheet normalization. The released document shows that most Fed officials believed that the U.S. central bank should start trimming its $4.5 trillion balance sheet later this year, in a gradual and predictable manner, accomplished mainly by phasing out reinvestments of principal received from those holdings.
“Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the Committee's reinvestment policy would likely be appropriate later this year”.
It means that the divergence between monetary policies conducted by the Fed and other major central banks could widen further later this year. Thus, the normalization of balance sheet may be positive for the U.S. dollar and negative for gold. However, the withdrawal of the Fed from the financial market could trigger some volatility, which could be beneficial for safe havens, such as gold. A lot depends on the pace of the shrinking of the Fed portfolio and the market reaction. The gradual and predictable way of trimming the balance sheet preferred by the Fed limits the risk of turmoil.
The second important thing in the FOMC minutes concerns the probability of fiscal stimulus provided by the new administration in the near future.
“Several participants now anticipated that meaningful fiscal stimulus would likely not begin until 2018. In view of the substantial uncertainty, about half of the participants did not incorporate explicit assumptions about fiscal policy in their projections. Nonetheless, most participants continued to view the prospect of more expansionary fiscal policies as an upside risk to their economic forecasts. At the same time, some participants and their business contacts saw downside risks to labor force and economic growth from possible changes to other government policies, such as those affecting immigration and trade.”
If Trump fails to implement pro-growth policies, the Fed could downgrade its economic projection and adopt a more dovish stance. It would be rather positive for the gold market, however lower inflation expectations could increase real interest rates.
When it comes to other issues, it is worth pointing out that some of the FOMC members were worried about the level of equity prices. Interestingly, they considered January soft consumer spending as temporary, but February turned out to also be weak.
The bottom line is that the March FOMC minutes were released and there were a non-event for the gold market. The price of gold declined yesterday, but the drop was probably caused by a strong ADP national employment report, a harbinger of strong Friday’s payrolls. The minutes did not reveal much new, but investors should not underestimate the potential consequences of the upcoming shrinking of the Fed’s balance sheet for the gold market.
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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