History may not repeat itself to the letter but it certainly rhymes. That’s what the Fed watchers would say now. The Fed cut the interest rates for the second time this year and the price of gold declined again. What is going on?
Fed Trims Interest Rates by 25 Basis Points
Yesterday, the FOMC published the monetary policy statement from its latest meeting that took place on September 17-18th. In line with expectations, the U.S. central bank cut the federal funds rate by 25 basis points, for the second time this year:
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-3/4 to 2 percent.
Interestingly, the decision was again not unanimous, as Esther L. George and Eric S. Rosengren wanted to keep the rates unchanged. It suggests that there is important internal opposition to further cuts in interest rates. On the other hand, James Bullard also dissented, but because he wanted to slash the federal funds rate by 75 basis points. Wow, does he sense the impeding recession?
Apart from the cut to lower level and Bullar’s dissent, the newest FOMC statement hasn’t changed much. It just noted that household spending growth had been recently strong, while business investment and exports had weakened.
The fresh economic projections were also largely unchanged from June. The forecasts for GDP and the unemployment rate barely moved compared to the June economic projections. More importantly, the outlook for inflation stayed as before, which means that the FOMC does not see disinflationary risks but believes that inflation will reach the target in 2021. If this is the case, there is no rationale for further interest rate cuts. And indeed, although the FOMC reduced them yesterday, they showed little appetite for further moves. The dot plot reveals that the median assessment of appropriate level of the federal funds rate is 1.9 percent for this and the next year. It is, of course, lower than in March, but this is exactly the level at which the federal funds rate stands right now. In other words, the FOMC members do not see further interest rates cuts in 2019 or 2020. What is more, the dot plot suggests one 25-basis point hike in 2021 and another in 2022.
Implications for Gold
The price of gold plunged below $1,500 after the release of the FOMC statement, as the chart below shows.
Chart 1: Gold prices from September 17 to September 19, 2019
Our Readers should not be surprised. We repeated many times that “buy the rumor, sell the news” is a very common trading strategy in the gold market. Just as gold prices were increasing after interest rate hikes in 2018, they are falling after the cuts.
Moreover, just as in July, the cut was hawkish or less dovish than expected. President Trump was clearly dissatisfied with “only” a 25-basis points move. He tweeted: “Jay Powell and the Federal Reserve Fail Again. No “guts,” no sense, no vision! A terrible communicator!” Poor Powell, he tries his best, but nobody loves him – neither the President, neither Wall Street.
Traders expected either a larger move or hints for further cuts in the remaining of 2019, but the dot plot suggests that the Fed will pause later this year. In other words, the dot plot seems to confirm Powell’s description of the July’s cut as a “mid-cycle adjustment,” not as the “beginning of a lengthy cutting cycle”.
In his latest press conference, Powell confirmed his view. He said:
What we believe we’re facing here, what we think we’re facing here is a situation which can be addressed and should be addressed with moderate adjustments to the federal funds rate.
As you can see, “moderate adjustments,” not aggressive cutting. We can just repeat our previous comment on this: “Not good news for gold”. You see, although the cut and the pause in the tightening cycle is fundamentally positive for the gold market (it removes a downward pressure on the prices), the yellow metal will probably not rally without the aggressive long rate cutting cycle.
However, despite Powell’s claims that the recent cuts are just an adjustment, we could see a more aggressive stance in the foreseeable future. This week, the New York Fed made an emergency injection of more than $125 billion to end a liquidity squeeze in the money market. It may be just an aberration, but history teaches us that such aberrations signal more problems in the financial markets in the future – and such problems usher in better times for gold bulls.
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