Precious metals talking points: The Fed; it's not how many, it's how much

By: Rhona O'Connell, Head of Market Analysis

Mon, 24 Jan 2022, 16:25

Watch point: Fed meets Tuesday and Wednesday; some key US numbers also due this week.

Employment has been the recent watchword – now inflation rejoins it

This first Federal Open Market Committee meeting of the year will not produce specific economic projections or the Dot Plot – they are confined to the meetings in the third month of each quarter. It will still be an important one, though, as we will need to read between the lines of the statement and what Jay Powell says in his Press Conference, particularly in the Q&A. The bond markets are easily discounting three rate hikes this year and there is some market chatter about possibly even four. As one of our senior bullion dealers noted last week, the gold forward curve, broadly in line with U.S. rates (as it should be; gold is more often than not found to be at, or close to, full carry) is also pointing to three rate hikes this year.

Or, more accurately, a 75-point rise overall. Some commentators are expecting a full 100 bp cumulative increase during this year.

So in this writer’s view, the number of hikes is somewhat less important than the overall size of them. Which begs the question – will the Fed go in aggressively in March with a 50-point raise, or will it take the more cautious approach, especially since we are now also talking about shrinking the balance sheet.

We have noted in the past few weeks that inflation is now part of the fabric of market observations, and it is employment that now takes centre stage. In the Press Conference following the most recent FOMC meeting, Chair Powell said that the economy has been making rapid progress towards maximum employment, with job gains averaging 378,000 over the previous three months and unemployment falling “substantially” to 4.2% in November. A key comment here also was the closing of the gap between employees at the higher end of the spectrum and these at the lower, as well as for Africans and Hispanics. We make this point because ethnic differentials was one of the parameters that Powell noted when asked to define maximum employment (for reference he listed the following: - unemployment itself, participation rate, job openings., wages, flows in and out of the labour force; also broadly and inclusively at different demographic members of the labour force; and that assessing maximum employment is a judgment call, not just a headline number).

So once the Fed is confident that we are at – and can maintain- maximum employment, the balancing act will again be looking to inflation. Mr. Powell is renowned for his cautious handling of the situation, even if he has become markedly more hawkish since renomination. With many market observers, including the Fed itself, looking for inflation to peak in the near future (although the outlook for crude and wages may yet tilt that belief mildly off course), the argument would appear to be for a 25-point hike in March, especially as the virus, while fading to a degree, is still rampant in the United States and remains a key variable. The Fed will not want to derail the economy and we still have supply chain dislocations to work through. At the most recent meeting the median FOMC projection for inflation at end-2022 was 2.6%.

It is now more or less accepted that balance sheet shrinkage (“run-off”) will start soon after the first-rate hike and once tapering has been completed. This is more of a velvet glove, while rate hikes are the iron fist; shrinkage will go on in the background, helping to give some buoyancy to bond rates, while rate hikes are discrete instruments with plenty of press coverage and a tangible impact on individuals in society. Experts at Oxford Economics are looking for tapering of roughly $400Bn in the second half of 2022 and $1Tn in 2023, which they put as the equivalent to 1.5 to 2.5 25-ppoint rate hikes.

So as we have noted before, if shrinkage allows for a more benign use fo rate hikes, that is supportive for gold; if they are both used with a degree of aggression that could choke of some of gold’s tailwinds and, indeed, become a headwind.

What else to watch for?

Key numbers out this week include:

PMI; released Monday, US Manufacturing, 55.0 in positive ground, but below expectations

US Services, 50.9 well below the 55.4 call

US Composite 50.8.

Tuesday: Conferenced Board consumer Confidence, called at 111.5 overall. Expectation and current situation not forecast but were 96.9 and 144.1 in December

Wednesday: Wholesale and retail inventories for December, called at +1.2% and +1.5% respectively after 1.24% and 2.0% in November. This will give some guidance as to supply chains

FOMC Rate decision 7pm Eastern Time

Thursday; Q4 GDP annualised Q/Q; forecast 5.3%

GDP Price Index called 6.0%

Core PCE Q/Q called 4.9%

Friday Personal income and spending; expected +0.5% and minus 0.6%

Core PCE Deflator y/y 4.8%

` UMich sentiment survey called 68.8.

durable goods orders for December; expected down 0.6%

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