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Chairman Powell confirms that recession or not, we will raise rates to lower inflation

Commentaries & Views

Speaking at the European Central Bank annual conference in Sintra, Portugal today Chairman Powell made it clear that the Federal Reserve was committed to reducing inflation even if it means raising interest rates to levels that put economic growth at risk. His comments reinforced that Fed will “do whatever it takes” with continued rate hikes to bring inflation back to the Federal Reserve’s target of 2%.

The chairman acknowledged that “there is a risk” that the Federal Reserve’s revised monetary policy will result in an economic contraction leading to a recession he said, "I would not agree that is the bigger risk. The bigger mistake would be to fail to restore price stability."

Because current forecasts suggest that tomorrow’s Personal Consumption Expenditures price index (PCE) report will reveal that inflation continues to remain more than triple the Fed’s 2% inflation target in May. If these forecasts are correct, it will increase the probability that the Federal Reserve will raise rates by 75 basis points at the July 26 – 27 FOMC meeting. Recently the Federal Reserve revised its “dot plot” to reflect approximately double the former inflation target by the year-end of 1 ½% - 1 ¾% to a minimum of 3.4%.

Although the chairman tempered fears of a recession by saying that the economy is “in pretty strong shape” and will be able to cope with tighter credit conditions while avoiding a recession or even a significant rise in the unemployment rate he added one major caveat. He said that the path to a “soft landing” will become “significantly more challenging” the longer that high inflation lasts.

New data suggests that inflationary pressures will remain exceedingly hot. Also the BEA today reported that “Real gross domestic product (GDP) decreased at an annual rate of 1.6% in the first quarter of 2022, following an increase of 6.9% in the fourth quarter of 2021. The decrease was revised down 0.1 percentage point from the "second" estimate released in May.”

The combination of Chairman Powell’s statements and advance forecasts suggests that inflation as seen through the PCE price index report tomorrow resulted in extreme dollar strength in anticipation of higher rates. Dollar strength was the net result of market participants focusing on interest rate hikes rather than on current inflationary pressures.

It was dollar strength that pressured gold lower today. As of 5:58 PM EDT gold futures basis, the most active August contract is currently fixed at $1819.20 after factoring in today’s decline of two dollars or 0.11%. Concurrently, spot gold is down $2.86 or 0.16%. The KGX (Kitco Gold Index) clearly shows that market participants were active buyers of gold today taking spot gold prices up by $8.20. It also reveals that dollar strength completely engulfed gains as a result of normal trading moving the precious yellow metal lower by $10.70 resulting in the current gold spot price of $1870.90 down $2.50 on the day.

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