By: Rhona O'Connell, Head of Market Analysis
The short-term impact of the Minutes from the December FOMC meeting has been another knee-jerk downward impact on gold, as Treasury yields have risen. This keeps gold entrenched in the range that it eked out in the final quarter of 2021 and gold currently still needs an exogenous shock to take it into a higher range. After the lack of reaction to the December Statement, it appeared that gold was taking a more hawkish attitude in its stride. While uncertainty swirls around the global economy, prices will find support; market participants, though. are understandably still wary of committing to a definitive strategy. So we are probably treading water for a while yet.
Gold, U.S. two-year yield, correlation
Source: Bloomberg, StoneX
Inflation and fed funds
The Minutes from the December FOMC meeting were more hawkish than the markets had expected. Considering the dot-plot, shown below, which was released on the evening of the Meeting in mid-December, and which implied three interest rate hikes by end-year, the comments in the Minutes show that the median respondents’ expectations for the first-rate hike had moved from March 2023 to June 2022, which seems to us to chime in with what came out of the post-meeting Statement. Especially as the Fed Desk comments also noted that “expectations for the federal funds rate at longer horizons did not appear to have risen” and also pointed out “all funds rate reported in the Desk surveys suggested considerable uncertainty about the path of the federal funds rate, as survey respondents placed significant odds on a range of outcomes”.
U.S. two-year yield steepens at higher levels overall from a month ago and medium-term tenors are a lot higher than a year ago
Source: Bloomberg, StoneX
Participants once again affirmed that “changes in the target range for the federal funds rate should be the Committee’s primary means for adjusting the stance of monetary policy in support of its maximum-employment and price-stability objectives” on the basis that the impact on these two key parameters is easier to forecast (and to gauge, for that matter) than shifts in the balance sheet, as well as being better understood and more immediately affected by the public at large.
The December dot plot
Source: U.S. Federal Reserve
Bond policy; gold headwind?
As far as tapering and “balance sheet run-offs” (reducing the balance sheet by letting bonds mature and not reinvesting the proceeds) are concerned, “participants noted that current conditions included a stronger economic outlook, higher inflation, and a larger balance sheet and thus could warrant a potentially faster pace of policy rate normalization”. They emphasized that the decision to initiate runoff would be “data dependent”, but that it would “likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate”. Balance sheet run-off, by implication, would underpin bond yields and could therefore be a headwind for gold.
Opinions were mixed as to what effect this policy might have on the yield curve, with some taking the view that it would limit the flattening of the curve, while on the other hand, others pointed out the fact that many factors affect longer-dated yields.
There is still a transitional element in inflation expectations with the Staff expecting PCE prices to end 2021 around 5%, but due to decline over the following two years with a partial reversal of the impact of supply chain issues, coupled with retreating energy prices.
Summary
In summary, progress on “vaccinations and an easing of supply constraints were expected to support continued gains in economic activity and employment as well as a reduction in inflation, but risks to the economic outlook remained, including from new variants of the virus”.
As we noted in our comments at the time, the word “transitory” had, however, disappeared from the Statement; the Minutes refer to this on the basis that elevated inflation had persisted for longer than they had previously anticipated. This, coupled with improvement in the labour market, triggered the decision to reduce the monthly pace of net asset purchases by $20Bn for Treasury Securities and $10Bn for Mortgage baked securities. Flexibility, of course remains the watchword.
With focus continuing to shift towards employment, which is a key driver of inflationary targets and policy implementation, all eyes now turn to the Nonfarm Payroll figures, which are released later today.
Therefore, this piece is to be continued…
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