The Fed left rates unchanged yesterday but with a caveat – 8 of the FOMC members now see rate cuts this year as appropriate versus none in March.
That number increases to 9 for 2020.
It is important to bear in mind that the federal funds rate (fed funds rate) is one of the most important interest rates for the U.S. economy, as it affects broad economic conditions in the country, including inflation, growth, and employment.
It is set in U.S. dollars by the FOMC and is typically charged on overnight loans. It is the interest rate at which commercial banks lend reserves to one another on an overnight basis.
Now the possibility of the FED reducing rates has been on the radar since January of this year when it reversed its Quantitative Tightening stance to one of being more flexible and allowing to all extent and purposes ceasing the tightening programme.
Many have mooted that the FED will have to reduce rates at least twice this year and we have held pretty firm by stating that if there is going to be a rate cut it will be 1 at most and then later in the year.
We were 90% certain of our position based on our own economic calculations (we were bankers after all and so have our own algorithms and calculations) but this reduced to 55% only because of the ECB Head – Mario Draghi – came out this week, ahead of the FED, and quite frankly undermining it somewhat – by stating the ECB will do what is necessary, to keep the economy afloat and if this involves lower interest rates and Bank bond buying (i.e. QE) then so be it.
Now there was the possibility that this would impact the FED and reduce rates yesterday – but really, we should have known better. Bankers make such decisions based on information gathered many days if not weeks ahead of its ritual 6 weekly announcement and only in the case of a dire emergency will it change its mind ‘on the day’ as it were.
So, what did yesterday tell us? Well the headliners will say something like “FED plans to Cut rates twice this year” – and expect the pumpers to do the same. But this is not what was said yesterday.
Basically, the FED stated that it does not expect any rate cuts this year but did forecast one or possibly 2 for 2020.
The giveaway words for a greater easing was when Powell stated:
“Many participants now see the case for somewhat more accommodative policy has strengthened.”
The FED is also concerned about inflation – not high inflation but low inflation – its statement yesterday changed to concede that inflation is “running below” the Fed’s 2% objective. In their forecast for headline inflation this year, officials reduced the estimate to 1.5% from March’s 1.8%.
The statement issued also added:
“In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2 percent objective.”
So, we have an interesting situation developing. Jerome Powell’s opening remarks were that he and his colleagues had
“One overarching goal – to sustain economic expansion with a string job market and stable prices for the benefit of the American people.”
Now this suggests they will do anything to ensure these areas are not jeopardised – thereby indicating a significant loosening of monetary policy.
On the other hand, he is also aware that the economy is relatively strong, and the trade wars are hindering it somewhat. If he reduces rates in July, the markets will expect another reduction before the end of the year. (In fact, some market analysts are building into their expectations 3 cuts this year which we certainly do not envisage).
What happens though if they did reduce rates twice this year and the China, Mexico, Iran, North Korea issues are all resolved? The FED could find itself in the position of having to raise rates again – which will affect its credibility and it will not want that to occur.
It makes much more sense for it to hold off beyond July and raise late autumn if necessary, or if it can wait until December or even early 2020. Rates will almost assuredly come down, but we are of the firm belief not as fast as stock markets in particular are expecting.
So, what about Gold and Silver prices then – how will they be affected?
Well since the announcement gold has risen to as high as $1386 from as low as $1341 an impressive $45 rise. Silver too has moved up in sympathy from a low of $14.93 to $15.38 a 45 cents increase.
At the time of writing this which is 3pm BST or GMT Gold stands at $1383 and silver at $15.38
So, is this the start of a new bull rally or confirmation of one, or is it just a kneejerk response to a confirmed expectation of lower interest rates?
Well, before we discuss that, its worth noting that the Bank of England’s Monetary Policy Committee (The equivalent to the FED’s FOMC) announced a short while ago that it will be holding interest rates at the current 0.75%. This was a unanimous decision by the 9 Committee members.
Part of the rationale is that it expects economic growth to be flat in the second quarter of 2019 when it had previously predicted growth of 0.2% over that period following a 0.5% growth in the first quarter of the year.
On Wednesday, it was announced that inflation had fallen to its target of 2% in May, easing pressure on the Bank to raise rates to keep prices under control. Retail sales figures also announced today show a fall of 0.5% between April and May – the largest fall so far this year.
The persistent threats by the Governor of the Bank of England to expect higher rates in the future appear relatively toothless. With both the ECB and the FED in effect, promising lower rates in the near future, it would be extremely difficult for the BOE to raise them and expect to remain competitive.
So, let’s get back to gold and silver.
Well firstly in sterling terms, gold has risen to its peak since September 2011. Yes, that was when gold reached its zenith in sterling terms at £1179 per oz and at £1091 its not that far away. There is no doubt that sterling has suffered during the Brexit situation and now with Boris Johnson the current lead contender to be the next Prime Minister promising a ‘Hard Brexit’ if necessary, markets are beginning to frighten and we may very well see gold rise even further and perhaps aim for that additional £80 to test the 2011 peak.
Silver is standing at £12.13 an ounce and paints a very different picture. Current levels were last seen in February of this year and are considerably lower than the £27.94 peak it reached in April 2011. Whether it will catch up is open to debate especially as the gold to silver ratio in is virtually 90:1
In US Dollar terms, gold is at a 6 year high last seen at these levels in June 2013 and as we know, peaked in September 2011 at just about $1900. Silver was higher than this level back in March of this year and like gold peaked in 2011 in March just shy of $47 though it had been a little higher back in the 70’s.
So where are US dollar prices going from here? Well the markets are expecting a number of rate cuts and soon, so they are pricing in a lower dollar value. We are not confident that is going to occur as quickly as markets expect; though the White House has let it be known, through certain channels, that President Trump is seriously considering sacking Jerome Powell for not reducing rates yesterday.
Stocks are certainly going to be the beneficiaries of this lower interest rate environment and the Dow is already up 4% this month at a little over 26,700 with similar percentages for the S&P and Nasdaq. The Dow’s highest closing record is 26,828 which it reached on 3rd October 2018 and we are confident markets will attempt to breach that figure.
Remember only a handful of months ago when the Dow Fell a few thousand points and pundits were claiming its going to crash at least 50% – we were one of a few lone wolves (if you can have a few lone wolves) stating not to be surprised if it aims to reach its previous peak – and here we are.
So, there is a quandary. Where are investors money going to end up – Gold or the Dow?
We suspect in US dollar terms, gold has witnessed the majority of its rise for now – yes there may be a few dollars extra to go, but unless tensions with Iran or China heat up further, we are probably near the ceiling. The Dow has the potential to explode if the China and Iran conflict is solved.
The difficulty though is not short term but in the coming months. If the FED does not reduce rates as anticipated and we suspect they won’t, then the stock market will fall back especially if Europe and the UK have done so by then. Then we may either see a flight to gold or interest-bearing investments. It is this issue that is difficult to forecast with any degree of accuracy until further economic data is received.
It could very well be the case that the FED will operate in unison with the President and reduce rates and create a further booming economy in time for the election in 2020. Then we have to weigh up the rise in price of gold because of a lower dollar value (on the basis the dollar does fall when compared to other currencies, which they themselves will be devaluing) or alternatively the flight from gold to stocks because the latter are on a tear.
Our view is, that at the moment, Gold may very well attempt to breach the $1400 and if it does, will run out of steam save the military infractions previously mentioned. Silver will follow gold, but with global demand down, unless the economic environment improves dramatically with all of this monetary easing, then the gold to silver ratio may even increase further until circumstances change.
Well yesterday was certainly exciting and just think we may have to go through exactly the same process again next month.