Bye, Bye, Forward Guidance!
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Tightening is coming, brace yourself! And we mean ‘tightening’, not just the removal of monetary accommodation. Why we think so? Let’s read our article about the recent FOMC minutes and find out!
Poor Gold, Economic Outlook Is Positive
Last week, the U.S. central bank published minutes from the recent FOMC meeting. How do the FOMC members view the economic outlook?
On the one hand, they noticed that “uncertainty and risks associated with trade policy had intensified and were concerned that such uncertainty and risks eventually could have negative effects on business sentiment and investment spending”.
However, they agreed that “information received since the FOMC met in May indicated that the labor market had continued to strengthen and that economic activity had been rising at a solid rate.” The central bankers also noted “number of favorable economic factors that were supporting above-trend GDP growth; these included a strong labor market, stimulative federal tax and spending policies, accommodative financial conditions and continued high levels of household and business confidence.”
Hence, their economic outlook is, on balance, quite positive. It’s bad news for gold, which clearly prefers recessions. Given the current optimistic assessments, the FOMC is likely to further normalize its monetary policy, which should hurt the yellow metal.
Forward Guidance Is Gone
Indeed, the FOMC removed the phrase that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.” Why is it so important? Well, it implies the removal of the forward guidance. As a reminder, the forward guidance was introduced to overcome the zero-bound interest rates. After the Fed slashed interest rates practically to zero, it could not cut them further. Hence, the central bankers decided to influence the expectations about the future short-term interest rates, influencing in that way the current long-term interest rates. The forward guidance became the key tool of monetary policy during the ZIRP. Now, the Fed decided to removed it:
With regard to the postmeeting statement, members favored the removal of the forward-guidance language stating that "the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run." Members noted that, alÂthough this forward-guidance language had been useful for communicating the expected path of the federal funds rate during the early stages of policy normalization, this language was no longer appropriate in light of the strong state of the economy and the current expected path for policy. Moreover, the removal of the forward-guidance language and other changes to the statement should streamline and facilitate the Committee's communications. Importantly, the changes were a reflection of the progress toward achieving the Committee's statutory goals and did not reflect a shift in the approach to policy going forward.
It means, as we have already pointed it out in the Gold News Monitor, the Fed is ending its accommodative policy. The progressing normalization of the U.S. monetary policy is negative for gold, which shines during periods of economic turmoil and central bankers’ exuberance.
More Hikes Are Coming
The recent minutes suggest that the FOMC members also change their views about the appropriate level of the federal funds rate in the future:
With regard to the medium-term outlook for monetary policy, participants generally judged that, with the economy already very strong and inflation expected to run at 2 percent on a sustained basis over the medium term, it would likely be appropriate to continue gradually raising the target range for the federal funds rate to a setting that was at or somewhat above their estimates of its longer-run level by 2019 or 2020(emphasis added)
Participants offered their views about how much additional policy firming would likely be required to sustainably achieve the Committee's objectives of maximum employment and 2 percent inflation. Many noted that, if gradual increases in the target range for the federal funds rate continued, the federal funds rate could be at or above their estimates of its neutral level sometime next year (emphasis added)
What does it mean? More normalization and further tightening. The neutral level is the level that neither boosts or dampens activity. If the Fed considers pushing the federal funds rate above the neutral level, it means that it does not only want to remove accommodation, but it actually does want to really tighten its stance. Unless the U.S. central bank tightens too abruptly, triggering recession, it should put downward pressure on the gold prices. Â
Implication for Gold
What are the take-home messages from the recent FOMC minutes? Well, its stance has been turning more and more hawkish. This is definitely not a good development for gold. The case is, however, not lost. The real interest rates have been recently declining, while the credit risk has risen somewhat. Our view is that unless the ECB starts to remove its monetary accommodation more decisively, the medium-term outlook for gold will remain rather bearish.