On Tuesday, Fed Chair Janet Yellen delivered a speech entitled “Inflation, Uncertainty, and Monetary Policy” at the 59th Annual Meeting of the National Association for Business Economics in Cleveland, Ohio. What can we learn from it?

At last week’s press conference, Yellen admitted that subdued inflation was a “mystery” for the FOMC. In yesterday’s speech, Fed Chair elaborated on the stubbornly low inflation. Generally, she still believes that low inflation likely reflects temporary factors whose influence should diminish over time. However, Yellen discussed many uncertainties related to the inflation outlook, or reasons behind missing inflation. In particular, she analyzed idiosyncratic shifts in the prices of some items, the subdued growth in health-care prices, and the globalization. She also examined the inherent imprecision in estimates of labor utilization, of inflation expectations, admitting that:

“My colleagues and I may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation.”

This is why for some analysts, Yellen’s speech was dovish. She suggested that the Fed may have overstated the strength of the labor market and, thus, inflation. And Yellen also noted that if the favorable supply-type shocks (like increased competition due to globalization) continue, “achieving our 2 percent inflation goal over the medium term may require a more accommodative stance of monetary policy than might otherwise be appropriate.” And she said that all these uncertainties strengthen the case for a gradual pace of adjustments.

However, markets interpreted Yellen’s remarks as hawkish, on balance. Why? Well, the bottom line from her speech is that the Fed needs to continue gradual rate hikes despite broad uncertainty about the path of inflation. She noted “the possibility that inflation may rise more sharply in response to robust labor market conditions than anticipated” and pointed out that the Fed should be gradual, but should not increase rates too slowly. The key part is probably as follows:

“But we should also be wary of moving too gradually. Job gains continue to run well ahead of the longer-run pace we estimate would be sufficient, on average, to provide jobs for new entrants to the labor force. Thus, without further modest increases in the federal funds rate over time, there is a risk that the labor market could eventually become overheated, potentially creating an inflationary problem down the road that might be difficult to overcome without triggering a recession. Persistently easy monetary policy might also eventually lead to increased leverage and other developments, with adverse implications for financial stability. For these reasons, and given that monetary policy affects economic activity and inflation with a substantial lag, it would be imprudent to keep monetary policy on hold until inflation is back to 2 percent.”

What is crucial here is the reference to financial stability. We believe that this is the main reason behind the Fed’s tightening despite subdued inflation. The U.S. central bank is simply afraid of negative consequences of persistently easy monetary policy (do you remember what happened a few years after Greenspan cut interest rates in 2001 and maintained them low until 2004?). And it does not want to be without ammunition when the next recession hit.

What does it mean for the gold market? Well, implications are rather bearish. The Fed is hiking, because it wants rates to be higher. Period. Forget about data-dependence and brace for an interest rate increase in December. The current market odds for such move are above 80 percent. Gold hates rising interest rates, so further price declines are likely. As a reminder, gold bottomed in both December 2015 and December 2016. However, the current market expectations of a Fed hike in December are already high, so the downside risk should be limited. Stay tuned!

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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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