- The Federal Reserve has left its policy unchanged, painting a gloomy picture.
- An open door to doing more implies further dollar weakness, exacerbating the falls.
- Stocks – that have benefited greatly from Fed support – may eventually run out of steam.
Reality bites – and the Federal Reserve has been unable to ignore it. The resurgence of coronavirus is already evident in jobless claims and consumer confidence figures – and the Fed probably has the Gross Domestic Product figures for the second quarter, reflecting the first wave's damage.
Here is a new sentence from the Fed:
The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.
The world's most powerful central bank acknowledgment of the deterioration is accompanied by a clear message – we will do more. Jerome Powell, Chairman of the Federal Reserve, may follow through with either more of the current tools such as more lending programs or standard bond-buying – or new ones, such as Yield Curve Control.
Flooding the markets with more dollars implies it may further lose value. The greenback's unique position as the world's reserve currency means cheap lending conditions could send funds overseas, boosting other currencies.
For gold, the Fed's commitment to do whatever it takes – even if that does not include negative interest rates – means more room to rise. Alongside much-hyped markets, forecasts for $2,300 or $3,000 for XAU/USD seem less outlandish.
What about stocks?
The S&P 500 Index is around the break-even level for 2020 – mostly fueled by Fed action. Funds that the bank facilitated in both bond-buying scheme and lending programs have propagated to the stock market.
Does more help mean more increase? At some point, there is a limit. Investors cannot take the Fed's help while ignoring the reason for all this effort – a dire economic situation stemming from the disease.
Hopes for a COVID-19 vaccine provide reasons for consumers and businesses to remain optimistic – but that may take time. The gap between elevated valuations and struggling earnings cannot be ameliorated by immunization hopes and Fed funds – not forever.
Markets may look at the Fed's underlying reason for supporting the economy and turn south as well.
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