On Tuesday, Fed Chair Janet Yellen delivered a speech entitled “The Outlook, Uncertainty, and Monetary Policy” at the Economic Club of New York. What can we learn from it?

The Good

As usual, Yellen reiterated in her speech to the Economic Club of New York that the Fed continued to expect further labor market improvement and a return of inflation to its 2 percent objective over the next two or three years. She also pointed out some positive economic developments, in particular a strong labor market (which added an average of almost 230,000 jobs a month over the past three months), consumer spending (really?), improved household balance sheets etc. Surely, the U.S. economy is generating new jobs, but what really matters for economic growth is not the sole number of jobs, but productivity growth, which has been recently disappointing. However, gold prices do not like positive economic news and strong job growth.

The Bad

However, Yellen perceptively noted: “readings on the U.S. economy since the turn of the year have been somewhat mixed”. In particular, she mentioned the suffering manufacturing, weak net exports and disappointing business investment (due to a decline in drilling activity and slow global growth). Generally speaking, Yellen strongly emphasized global developments, arguing that slow world economic growth “would tend to restrain U.S. economic activity”. The biggest downside risks to the economic outlook are developments in China and the price of oil, according to Yellen. Moreover, she pointed out that the inflation outlook had become more uncertain as inflation expectations had drifted lower. Consequently, “the decline in some indicators has heightened the risk that this judgment could be wrong. If so, the return to 2 percent inflation could take longer than expected and might require a more accommodative stance of monetary policy than would otherwise be appropriate”.

The Ugly

Given the risks to the outlook, Yellen considered it appropriate for the Committee to proceed cautiously in adjusting policy. Surely, caution is required, but whether one quarter-point hike a year several years after the end of recession would be careful enough? Fortunately, Yellen reassured that the Fed had considerable scope to provide additional accommodation. If things go south, investors may expect the return of ZIRP and the replay of quantitative easing, according to Yellen. That’s a great weight off our shoulders! Everybody knows that these monetary tools led the U.S. economy to the fastest economic recovery in the history. Oh wait…

For us, this is the biggest problem with the Fed. Yellen believes that the U.S. central bank is data-dependent and monetary policy only responds to the economy’s twists and turns, but she fails to notice that the Fed is the very reason of these twists and turns, exerting important negative effects on economic growth. In particular, the ZIRP has been misallocating business investment into financial assets rather than real assets, which has been reducing long-term productivity. In a zero interest rates environment, corporations have understandably preferred share buybacks rather than investing in growing their businesses.

Yellen’s Speech and Gold

Fed watchers expected Yellen to be dovish yesterday. She did not disappoint them. In consequence, gold prices jumped to above $1,240 after Yellen’s speech to the Economic Club of New York. The markets interpreted her remarks as dovish and in consequences the U.S. dollar weakened, which was bullish for the yellow metal. Yesterday’s reaction confirmed that gold is sensitive to U.S. monetary policy. Last week, gold was under selling pressure due to hawkish comments from several Federal Reserve regional bank presidents. Yellen’s remarks were in contrast to them, and reduced the chances of a Fed hike in April. The softened expectations of the pace of monetary tightening should be bullish 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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