By: Rhona O'Connell, Head of Market Analysis
Yesterday’s FOMC meeting saw a 75-point rate hike and the promise of more to come. As far as gold is concerned, a 75-point hike was more or less already baked into market expectations and the policy, as outlined, was also much as expected. Jay Powell made the point that by the time the Committee reaches its “moderately restrictive” target rates of between 3 and 4%, this would take the longer end of the curve into positive territory in real terms. For now, though, the ten-year yield, which is one of the tenors that informs gold market sentiment, remains firmly below zero at 3.3% nominal. Inflation containment, and particularly inflationary expectations, are right in the Fed’s crosshairs and Mr. Powell retained his usual adherence to the need for flexibility in “highly uncertain” times. Uncertainty is generally a tailwind for gold and this, coupled with a tone from the floor of the Press Conference that suggested a perceived dent in the Fed’s credibility, should be supportive, though not necessarily bullish, for gold – especially while the physical markets remain subdued. For now gold looks like a bargain-hunting ground rather than a bull-ring.
The details: -
75-point hike to target range of 1.5% to 1.75%
While the dot plot shows a range of end-2022 forecasts of the fed funds range of 3.0-4.0%, and 50 points higher in 2023, the forecasts for 2024 are wide-ranging, and lower.
Herewith the median forecasts from the FOMC
There was nothing fresh in the Statement – elevated inflation exacerbated by Ukraine, China; unemployment remains low and job gains have been robust in recent months. “Ongoing increases in the target range will be appropriate”. The Press Conference was much more revealing.
From the Press Conference: -
“Overall economic activity edged down in the first quarter, as unusually sharp swings in inventories and net exports more than offset continued strong underlying demand. Recent indicators suggest that real GDP growth has picked up this quarter, with consumption spending remaining strong. In contrast, growth in business fixed investment appears to be slowing, and activity in the housing sector looks to be softening, in part reflecting higher mortgage rates”
While labour demand remains extremely strong, labour supply is subdued with the participation rate steady [62.3%]; the Committee expects this imbalance to narrow, reducing upward pressure on wages.
The rate of wage gains has slowed already, albeit not by much [annual rise in May was 5.2%; monthly increases are just over 0.3% pm, which equates to 5.3% p.a. but on a downward path]
Jay Powell noted that the Committee will be looking over the coming months for “compelling evidence “that inflation is moving down”; and that “today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common. From the perspective of today, either a 50 or 75 basis point increase seems most likely at our next meeting. We will, however, make our decisions meeting by meeting, and we will continue to communicate our thinking as clearly as we can”.
Asked what a 75-point hike would achieve that 50 wouldn’t have; he said that they had expected that by this stage inflation would have been flattening and of course it’s surprised to the upside. Projections for this year have moved up notably so they thought that strong action was needed; over the past seven months (when hikes started) “we’ve seen financial conditions tighten but the fed funds rate, even after this move, is only 1.6%”. They now want to do more front-end loading with the aim of gaining more flexibility over the speed with which they can change rates thereafter. They want policy to be at a “moderately restrictive” level by end-year, which points to 3.0-3.5%, but this is all highly data -dependent.
A range of 3.5-4.0% is seen as the appropriate path for next year in order to achieve inflation back down to ~2%. Note that this is more or less in line with where the bond market is now.
Part of the use of the policy rate is to moderate demand. A rate of 3-4% is plausible to bring this about and would take more or less all the yield curve into positive real territory.
Did they see anything in the inflation expectations data that was unsettling enough to risk eroding their credibility of their verbal guidance by doing something so different from what they had “socialised” before? Across a broad range of data, expectations are for high inflation in the short term, but a lot lower further out. If they see “even a couple” of indicators that bring this into question then they take it very seriously”. He noted that the UMich preliminary reading was “quite eye-catching” and the index of common inflation expectation at the Board has moved up after being “pretty flat” for a long time and they are taking this seriously. Absolutely determined to keep expectations anchored at 2%.
“So would another tick up in expectations put a 75 or even 100 point in play in the next meeting?”. Answer included the following; “the main thing is to get rates up and restrictive policy is appropriate”, but he strongly implied that they don’t yet know how restrictive they will need to be. Data-dependent, indeed.
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