As markets had expected, the Fed finally removed the promise to be patient yesterday, setting the table for an interest rate hike this year. However, the March FOMC statement was interpreted as dovish, which weakened the greenback and strengthened the gold prices. Why?
Gold rose after the publication of the FOMC statement from $1150 to $1170. Is this not a bit strange, taking into consideration that the U.S. central bank dropped the promise to be “patient” with an interest rates hike? Not at all. First, the change in forward guidance was widely expected.
Second, the Fed finally acknowledged weak economic activity in the first quarter –- and admitted: “ ”.
Third, the new dot plot, which is part of thereleased along with the statement on monetary policy, shows the predictions of the federal funds rate by FOMC participants, and the chart suggests that the expectations of the level of federal funds rate over the next couple years have dropped. The March median prediction of the level of the federal funds rate for the end of 2015 stands at 0.625 percent, down from 1.125 percent in the previous statement.
It clearly signals a more dovish sentiment among the FOMC members than in December, mainly due to softer economic growth and stubbornly low inflation, significantly below the long-term target.
Fourth,, Yellen stopped to be patient, but simultaneously tried to cool expectations during the press conference, by repeating a few times that the change in forward guidance “ ”. The Fed said: “the Committee judges that an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting”, however this does not mean that “an increase will necessarily occur in June, although we can’t rule that out”.
What does the March FOMC’s meeting mean for the financial markets and gold prices? In a sense it does not change anything. The Fed still wants – at least officially – to raise rates, but the data is not yet supportive (low inflation, sluggish wage growth). However, this does not preclude a hike this year, because without taking some actions the Fed would lose its credibility, although it repeats all the time that its monetary decisions are data-dependent.
On the other hand, the last FOMC meeting entails serious short-term consequences. It shifted expectations on the initial interest rate hike from September to October. Before the FOMC statement, the probability of a September rate hike stood at 55-60 percent, while now Fed funds futures are pricing in a 41 percent chance of a September hike and a 61 percent chance of an October rate hike, according to. More dovish expectations about the timing and magnitude of the initial hike may stop the U.S. dollar’s rally in the short term and strengthen gold which has behaved relatively well during the period of low real interest rates, weak U.S. dollar and economic slowdown.
To sum up, the Fed removed the promise to be patient, but it is still going to tighten its monetary policy this year. However, the pace of the hikes will be slower, which is good news for gold for the short term, since the smaller the hikes, the better for the yellow metal. But investors should be aware that the U.S. dollar may still be gaining in the long term due to the global easing of the monetary policies, which could put some downward pressure on gold.
Sunshine Profits‘ and Editor