Last week, the minutes of the Federal Reserve’s May meeting were released. What do they say about the Fed’s stance and what do they mean for the gold market?
Everything is Fine, Slowing Just Temporary
How can we summarize the recent FOMC minutes? First of all, the FOMC members agreed that the labor market strengthened further even as growth in economic activity slowed in the first quarter. However, the U.S. central bankers viewed the slowing as likely to be transitory, due to such exceptional factors as “low consumer spending for energy services induced by an unusually mild winter and a decline in motor vehicle sales from an unsustainably high fourth-quarter pace.” And the Fed officials considered inflation as running close to the Committee's 2 percent longer-run objective.
Brace for Hike in June
Therefore, the FOMC members’ assessments of the medium-term economic outlook had changed little since the March meeting. Generally, they continued to see the near-term risks to the economic outlook as roughly balanced. Actually, many participants “saw the risks stemming from global economic and financial developments as having receded further over the intermeeting period.” It implies that the Committee’s gradual approach to raising the federal funds rate will be continued. Indeed:
“Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation.”
Hence, unless a negative economic shock occurs, we expect an interest rate hike in June. Investors think similarly, as the market odds of an upward move in two weeks are above 84 percent. Thus, gold may be under pressure for some time, but its price should rise after the actual event, at least if history is any guide.
Balance Sheet Normalization Gradual and Predictable
We learned more details about unwinding the Fed’s huge balance sheet. Nearly all FOMC members expressed their satisfaction with the proposed approach to end the reinvestment of principal of maturing securities gradually, rather than halting reinvestment all at once. The Fed will not sell its assets, but will let them shrink in a slow, but accelerating manner. Initially, only a small part of securities would be allowed to roll off, but the cap would be raised every three months, so the amount of reductions would increase in a predictable way:
“Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve's securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalized.”
As we wrote in the latest edition of the Market Overview, the Fed’s shrinking balance sheet is likely to be conducted in a very conservative and cautious way to minimize market volatility and disruption, so investors should not bet on doom scenarios and expect that the price of gold will necessarily shine during the normalization process.
Conclusions
To sum up, the May FOMC minutes were released and there were generally a non-event for the gold market. The reason is that they did not contain any surprises. The Fed is likely to hike in June, but the move has been probably priced in already. The new thing were the details about balance sheet normalization which confirm that the process will be very gradual and predictable, which should minimize the safe-haven demand for gold, although important uncertainty about the consequences of this process remains. Stay tuned!
Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.