The much-anticipated US Federal Reserve Board meeting and accompanying statement and press conference occurred overnight.
I’m really not sure what all the anticipation was about. As far as I’m concerned, the result was a foregone conclusion. The Fed didn’t disappoint. The Financial Review reports:
‘Washington DC | The US Federal Reserve foresees the economy accelerating quickly this year but still expects to keep its benchmark interest rate pinned near zero through 2023, despite concerns in financial markets about potential higher inflation.’
As Chairman Powell said, the Fed will keep rates low even in the face of higher inflation. The plan is to let inflation run above 2% and get comfortable, it will stay there before even thinking about increasing official rates.
I know, I know. In the real world, inflation isn’t below 2%. There is asset price inflation that is off the charts and normal consumer price inflation that is hidden by falls in size and quality of goods and services. But central bankers don’t deal in real-world stuff. So you have to accept their definition of inflation if you want to play the game.
And their definition of inflation excludes ‘volatile’ food and energy prices. And until unemployment falls to low levels and puts pressure on wages, there is very little chance of ‘inflation’ getting out of hand.
The message here is that rates are staying low for years to come. And even when they do rise, it will be on the back of rising inflation. So the idea is to ensure that REAL rates (the nominal rate minus inflation) remains low or negative for a loooong time.
Remember, the world is swimming in debt. Most of it is government debt. The only way to get out of this debt hole is to inflate it away. You do that by holding real rates below zero for a very long time.
If you’re wondering how to play this market over the next few years, I highly encourage you to check out my ‘Life at Zero’ presentation. In it, I explain how you can invest sensibly (and not take crazy risks) in a market where interest rates will be at zero for years to come.
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The Fed also said it will continue with its $120 billion per month of government bond and mortgage security purchases. That’s nearly US$1.5 trillion of indirect government financing per year right there.
Surely all this ‘money’ will lead to an ‘inflation’ rate well above 2% and interest rates will have to rise faster than expected?
Gold’s correction may be over
You see, the problem is that the response to COVID dealt a fatal blow to the US economy. More money may have been pumped into the economy, but the velocity of that money has slowed to record lows.
You can see that in the chart below:
Source: Federal Reserve Economic Data
That’s what a broken economy looks like. Good luck generating sustainable inflation in it!
In case there was any confusion, the market liked the Fed’s announcement. At the close the Dow was up 0.6%, the S&P 500 0.3%, while the NASDAQ advanced 0.4%.
The 10-year bond yield increased a few basis points to 1.645%. Just on that, there was a question at the press conference from CNBC’s Steve Liesman about whether the Fed was contemplating yield curve control.
Powell obviously knew the question was coming. In response, he read a scripted answer that didn’t answer the question. Rather, he just said that the Fed was happy with its US$120 billion per month asset purchasing program.
In other words, there will be no specific targeting of bond yields at this stage. That tells you the Fed isn’t too concerned by yields trading at 1.65%. And why would they be? Yields are still very low, and a healthy economy should be able to handle much higher rates than that.
But, as I just said, the US economy is far from healthy. The Fed may not want to show any concern at this stage but should yields increase above 2% and head towards 2.5%, I doubt they will be so sanguine.
Despite the lack of action on the yield curve control front, gold liked the Fed’s statement too. It jumped over US$10 an ounce and now trades around US$1,744 an ounce.
Gold was responding to the fact that the Fed is all but saying it supports the idea of holding real rates low or negative for years to come.
It’s a good message for gold to hear. Average long-term REAL treasury yields have been rising this year. On the first trading day of the year, they were -0.50%. But they have since come down and on 12 March hit a high of 0.07%.
So they’ve moved ever so slightly into positive territory. That’s why the gold price has been under pressure this year. But gold has rallied off its lows over the past few weeks. I don’t know if that’s just a pause in the downtrend that began last year. But it could be that gold is seeing a future where the Fed is happy to let inflation rise and do nothing about it.
If that’s the case, gold’s correction may be over…
Editor, The Rum Rebellion
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