What a month, traders. What a month it’s been so far. This is the space where, up until Sunday evening, I was planning on offering our usual recap of the FOMC’s announcements and press conference that were to follow the March meeting scheduled to end today. Of course, that changed when the Federal Reserve’s moment to act was pulled forward to Sunday where they announced an emergency cut of 1%-- their second inter-meeting move in as many weeks—and a new program of QE (Quantitative Easing) operations that will target total asset purchases of $700 billion.
In our weekly economic previews (posted every Monday) and market wraps (posted every Friday) this month, I’ve given kind of short shrift to these two moves by the Fed, given their importance. In the case of the former it was because I assumed this week’s FOMC coverage would be the better opportunity, for the later it was because on Monday morning the market was still digesting the move. So, rather than just leave off from posting on a canceled Fed Day I figured we should take a brief look at the two rate cuts and talk about how the Fed forecasting landscape has changed and what it all means (maybe) for gold prices in the medium term.
Tuesday, March 3: The Fed Lowers Short-Term Rates by 0.50%
The FOMC’s surprise cut at the start of the month marked the first time since the 2008 financial crisis that the Fed has enacted an emergency inter-meeting policy change. While the 0.50% cut served the textbook purpose of such cuts to support US businesses by “loosening” the money supply, it was clear that what the FOMC was really attempting to do was to reassure the American economy as a whole—business owners, investors, and consumers—that the Federal Reserve was ready to act in order to support the continuation of the economic cycle under the constrictive conditions driven by efforts to manage the growing Covid-19 pandemic.
Looking at the markets, we saw the usual responses in Fed-sensitive asset prices. Treasury yields dipped lower, most significantly in the form of the benchmark 10-year yield falling below 1%, while the Dollar lost some index value as it became somewhat less attractive to yield-seeking* investors. (*This, of course, was before the gargantuan flight to safety over the last 10 days, back when there seemed to still be investors doing anything other than fleeing from risk.)
At first, US equity markets responded as the Fed would have hoped, with the S&P rebounding from loses to find its way roughly 1.5% higher during morning trading. At the same time gold burst higher, as the yellow metal typically does in the event of a suddenly announced rate cut. Gold, in opposition to the Dollar, usually benefits from a low rate environment as it is itself a non-yielding investment and so broadly lowered interest rates reduce the opportunity cost of positions.
Highlight: “The market’s kind of telling us that it needs something more than monetary policy to impact this virus that we don’t know ultimately how it’s going to influence the real economy,” Brandywine Global Portfolio Manager Jack P. McIntyre says. pic.twitter.com/kTU10xaGkB
— Yahoo Finance (@YahooFinance) March 3, 2020
As you know, the rally didn’t last for the stock markets. Although the FOMC had made a relatively strong move to reassure the markets of stability through the spiraling health crisis, what truly drives a market narrative is not what the Fed does, but rather how it is perceived. In this case, what asset managers and investors took from the inter-meeting cut was a signal that the impending crisis barreling toward the US economy was big enough to unnerve the Fed and compel action well before a scheduled FOMC meeting. Equity prices sharply reversed their intraday gains and would close Tuesday’s session at a loss of nearly 3%.
While gold prices continued with strength through the week, the yellow metal never quite had the rocket boost that we might expect to see beside tumbling equity prices in other market environments. This was our first indication that, as we learned in the coming sessions, the need for cash and liquidity throughout global markets was putting even greater pressure on gold value than we realized at the time.
Sunday, March 15: The Fed Drastically Cuts Rates to Near-Zero, Announces Start of $700 Billion in QE Operations
Ahead of this weekend, the environment had materially changed/worsened: US equity markets have plummeted to-and-through the end of the longest running bull market in US history, and gold prices have disintegrated giving back every dollar gained since Christmas. It was very much as if, less than two weeks later, the Fed’s surprise 50-bip cut never even happened.
Through that lens, many were anticipating another more drastic move to be made by the FOMC at this week’s scheduled meeting but were still caught by surprise when the Fed decided to supersede the calendar and announce a massive cut of one full percentage-point on Sunday evening along with a return of an equally immense QE operation. While the March 3 cut was meant to confer confidence to the American economy ahead of a possible economic shock, Sunday’s move was a dramatic attempt to brace the economy and its participants as the shockwaves of crisis began rippling through the financial system.
There’s little need to rehash the details here; in part because just three days removed we are very much swimming in the after-effects of the move, and also because the mechanisms within Sunday’s FOMC moves are overall the same is we saw on March 3, with one important caveat. The magnitude of this move was much greater, and so the market reaction has been magnified in kind: stocks and gold prices briefly rallied again, but by the start of US trading on Monday global equities were being routed to limit-lows and gold had lost nearly $100 from the Sunday night high-tick, collapsing back through $1500/oz.
— Bloomberg Markets (@markets) March 16, 2020
Other Fed Actions
For the sake of completion, I do want to mention that the Fed is undertaking other strategies in an effort to support the US economy as well as promote stability in the financial system which is, and will continue to be, under a disproportionate strain. These efforts include a plan for over $1 trillion in liquidity operations to support repo/money markets, as well as working with its other key central bank partners to boost liquidity in the global system. I mention these to give you a more comprehensive idea of the efforts underway, but as they don’t have a clean correlation with gold markets we don’t need to explore them farther today.
What’s Next for the Fed, and What Does This Mean for Gold Prices?
When trying to plot the Fed’s near- to medium-term path, until the current crisis around Covid-19 and its economic drag passes, or at least changes, the option is fairly binary: either the Fed will follow the forward guidance offered on Sunday and hold rates at near-zero “until it is confident that the economy has weathered recent events and is on track,” or else a greater shock will come along and possibly force the Federal Reserve to break one of its last unthinkable taboos and cut US policy rates into negative territory for the first time in history. I believe the former is blessedly more likely than the latter, but this is not investing advice and you’d better be grateful for that because I don’t think anybody knows for sure.
As many observers have been saying, several with much bigger megaphones than mine and including members of the FOMC, the Fed is reaching the limit of how monetary policy can support the US economy— for now, that limit looks an awful lot like the line for 0% short-term interest rates that we reached this week. What will almost certainly be needed is a large wave of fiscal policy stimulus to directly support the American consumer. That machinery has been grinding into motion this week, but we are still waiting to see exactly what measure will come and how much impact they can have.
All the same, the headline for gold prices is simple: interest rates will remain lower for foreseeably longer. At the moment, that low-rate environment is not doing a whole lot for gold’s market value as the all-consumer rush to “sell what you can” has, as we’ve been discussing in recent weeks, hit gold harder than most safe havens.
But based on the last decade we can be relatively certain that, when the American economy pulls itself to the other side of this crisis, the return to higher interest rates will not happen even half as quickly as we have seen rates cut to zero this month. To gently transpose the old traders’ saying: elevator down, stairs up. So, when the margin calls ease up and the flight to cash slows—and, one way another, they will—markets will still trade for some time in a low-interest rate environment that in the medium term should lend some upside to gold as an investment and inflation hedge.
The trick, or course, will be knowing when that will happen. If you’ve got a crystal ball, traders, you know where to find me.
I’ll everybody back here on Friday or our market wrap of the week.