On Wednesday, the minutes of the Federal Reserve’s December meeting were released. What do they say about the Fed’s stance and what do they mean for the gold market?
How can we summarize the?
- The FOMC members observed that the labor market had continued to strengthen, the economic activity had expanded at a moderate pace, while inflation had increased significantly since midyear. This evolution of economic conditions warranted an interest rate hike in December, as we all know.
- The Fed officials also noted that nominal yields on Treasuries, the value of the dollar and the equity indices rose substantially since the U.S. presidential election, while credit spreads narrowed, signaling an improved risk sentiment. Importantly, the increase in nominal yields reflected both an increase in inflation compensation and higher real interest rates. All these factors were important fundamental headwinds for the price of gold in the fourth quarter of 2016.
- Almost all central bankers pointed out that the upside risks to their forecasts for economic growth had increased “as a result of prospects for more expansionary fiscal policies in coming years”. Some participants also noted the greater upside risks to their inflation forecasts.
- Therefore, these risks imply that there may be a faster pace of tightening if the U.S. economy continues to improve. The probably most important paragraphs from the recent minutes are as follows:
“Many participants judged that the risk of a sizable undershooting of the longer-run normal unemployment rate had increased somewhat and that the Committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures.”
“Several members noted that if the labor market appeared to be tightening significantly more than expected, it might become necessary to adjust the Committee's communications about the expected path of the federal funds rate, consistent with the possibility that a less gradual pace of increases could become appropriate.”
However, gold shrugged off these hawkish tones in the minutes. Why? We see four main possible answers. First, investors expected more hawkish signals, so they focused on dovish tones, such as worries that further appreciation of the U.S. dollar could restrain the economic growth. Second, the December ADP employment report was soft. Third, the U.S. dollar weakened against the Chinese yuan and other currencies as well. Fourth, the optimism about the new presidency vanishes as we get closer and closer to Inauguration Day. We wrote many times in our Gold News Monitor that Trump’s rally is not likely to be sustainable in the long run. Perhaps, we are now witnessing the change of market sentiment, but it is too early to declare it with certainty. It goes without saying that such a reversal would be positive for the gold market.
The key takeaway is that the December FOMC minutes were hawkish, but not hawkish enough to further suppress the gold prices. Actually, the yellow metal rose to a one-month high yesterday on a weak greenback. Well, some correction in both the U.S. dollar and gold is not surprising, but it may be too early to trump a lasting reversal in the gold market. As we argued in the yesterday’s, “the trend remains to be down”. Stay tuned, the Employment Situation Report is due today and it may entail some important developments for the gold market.
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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.
Sunshine Profits‘ and Editor