Economic conditions, market performance worsen after Fed rate hike

Precious metals markets are trying to tough this week despite another large rate hike by the Federal Reserve.

On Wednesday, the Fed raised its benchmark interest rate by three quarters as expected. Fed chairman Jerome Powell vowed to bring inflation down and restore price stability.

Jerome Powell:

My colleagues and I are strongly committed to bringing inflation back down to our 2% goal. We have both the tools we need and the resolve that it will take to restore price stability on behalf of American families and businesses. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone. We are moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%. The longer the current bout of high inflation continues the greater the chance that expectations of higher inflation will become entrenched.

After pursuing ultra-loose monetary policy that fomented price instability and massive inflation in the first place, Powell seems to now want to model himself after former Fed chairman Paul Volcker. In the early 1980s, Volcker jacked up interest rates to the highest on record to finally curtail the inflation surge from the late 1970s. 

Back then, though, U.S. finances were comparatively healthy. Debt levels were manageable. And financial markets hadn’t been artificially pumped up by zero interest rate policy and Quantitative Easing.

Powell has only just begun to reduce the size of the Fed’s massive balance sheet. In response, Wall Street is reeling. Housing appears to be tipping over. And the economy is slumping into recession.

Powell suggested in remarks following the rate hike decision that getting out in front of inflation is more important than trying to engineer a soft landing for the economy. Effectively, he has given up on preventing a recession.

The only question is how severe it will be. Since Fed policy decisions typically take at least three months to work their way through the economy, things could get significantly worse heading into the end of the year.

Whether things will get worse for investors in major asset markets remains to be seen. 

The bond market appears to be in the midst of a secular decline. After nearly four decades of functioning as a safe haven for conservative investors, Treasuries are now hitting holders with massive losses thanks to inflation and rising rates.

The stock market isn’t looking much better. Inflation and rising rates are depressing real earnings growth and compressing valuations. And if the economic backdrop continues to worsen, so will the prospects for corporate profits.

As for precious metals markets, they haven’t exactly been delivering stellar returns of late either. They have faced the headwind all year of Fed rate hikes boosting the U.S. dollar’s exchange rate versus foreign currencies. 

But there have been some positive divergences forming in the last few weeks, especially in the silver market. Silver is showing some relative strength versus financial assets, other commodities, and gold as well.

Silver has made some progress on the charts since prices bottomed at the beginning of the month. Bulls have reason to be encouraged, and they are hoping silver can soon break decisively above the $20 level. 

Some more backing and filling is possible, though, until we get a new catalyst for a big advance. At this point the most likely one would be disappointing economic data. 

The Fed’s rate hikes and tough talk on inflation are supporting the U.S. Dollar Index for now. But rising joblessness, falling manufacturing activity, slumping home sales, and disappointing GDP numbers in coming reports could signal a hard landing for the economy.  That would effectively force central bankers to back down.  

And as markets are always forward looking, we can expect currency and precious metals markets to begin reflecting a dovish Fed pivot before it actually happens. Investors who wait until the Fed announces it’s finished hiking rates before positioning themselves for a declining dollar will likely miss out on some solid gains in hard assets.

Those who try to engage in short-term market timing risk being on the wrong side of sudden and unpredictable price swings. But those who continue to hold their core positions, and add to them regularly as they are able, can be sure they will be on board for the next big breakout.