At the close of the first FOMC meeting of 2019, Federal Reserve Chairman Jerome Powell delivered the dovish Fed Day that markets were expecting. And then some.
Jerome Powell signals the Fed won’t raise interest rates again until inflation accelerates https://t.co/umTt9SIcNf
— Bloomberg Economics (@economics) January 31, 2019
The decision to leave short-term rates unchanged, and the slight downgrading of language in the statement assessing US growth were both well-priced into the market; but the prepared remarks about flexibility in managing balance sheet runoff, and the near elimination of forward guidance in the committee’s statement clearly had not been, as shown in the reaction of major assets classes.
Short-Term Rates Unchanged
As was anticipated by markets and investors alike, the Fed has left their target for short-term lending rates unchanged this month and Chairman Powell has reiterated that they have reached the target range within which the committee judges rates to be “neutral.” With multiple headlines coming out of the January statement and press conference there’s enough noise to make it difficult to say with certainty which asset move was influence by which specific piece of the statement, but I do feel confident in saying there was very little movement—if any—created by the news that short-term rates remain unchanged. It is the non-decision we all saw coming. Not true with the additional content in the statement.
Data-dependent Balance Sheet Runoff
Some kind of comment on (or, at the very least, reference to) the future of the Fed’s balance sheet—once swollen by the unconventional monetary policy of Quantitative Easing, now being allowed to “runoff” as those purchased bonds mature—was baked into everyone’s expectations for the January meeting, just as was the case with a no-move rate decision. A majority of observers, myself included, predicted that these comments would mostly come during Powell’s Q&A following prepared remarks; the theory being that using the committee’s statement to essentially rollback the Chairman’s previous suggestion (that the runoff is and would remain “on autopilot”) would be too strong an implication that the FOMC is considering tapering that process as a form of easing financial conditions—Powell wouldn’t so nearly commit to that course of action this early in the game. We thought. Wrongly, as it turns out.
In addendum to the committee’s regular statement, the FOMC took the time to clarify—to firmly state—that the path the balance sheet will take from over-stuffed to “normal” is very much data-dependent. Most importantly, the committee recognized that active management (tapering) of the Fed’s portfolio of bonds could act as a tool to loosen financial conditions if needed and affirmed their willingness to use it as such.
To me, this is the big deal for gold traders in Wednesday’s goings on. Despite repeating both the statement and the press conference Q&A that the committee views that US economy as “solid,” Powell in a way contradicts that statement by taking such meaningful steps to coddle to equity markets’ fears of tightening conditions. In looking comparing the reactions of the equity markets to those seen in gold and the dollar, we see that one asset’s investors are reacting to the short-term implications of the Fed’s statement while the other is perhaps positioning the longer-term consequences. We saw equity markets rise, cheering the idea that the FOMC so willing to “listen” to the markets that strained under the perception of continued rate-hikes and tightening conditions. But at the same time—and, I’d argue, to a greater degree—we see that the weighted indices of the US Dollar have slumped on the news while gold prices reached new heights: today ticking as high as $1325 in spot markets. I think investors in these assets are taking the longer view: The Fed’s (perhaps slavish) willingness to placate equities markets should go some way to keeping the good times rolling this late in the economic cycle. But the subtext of the committee’s language this week might also suggest that they see the end of the rate-hike cycle coming faster than before and are beginning to position for the start of rate cuts—an environment that historically fosters a weaker Greenback and a richer market for gold.
The End of Forward Guidance?
We’re being left to speculate a little more than in the recent past and read the tea leaves because of another somewhat surprising shift in the FOMC and Powell’s language; one that didn’t carry the direct impact on price action that discussion of the balance sheet did, but I still believe it will come into play gold markets down the road. By removing from the statement that the committee expects further hikes to be appropriate, and instead stating that the Fed is prepared to make adjustments to the short-term funds rate, Powell & Co. have essentially removed any forward guidance from their remarks. In his press conference, Powell drove it home. As reported by Bloomberg:
“Asked Wednesday in his latest press conference if the Fed still saw its next rate move as more likely to be up than down, Powell made it clear that was not his expectation.”
It’s my view that entering into a new phase where the Fed is going to lean much less on forward guidance, if at all, in their directed statements, then we’ll see a marked increase in volatility over time in markets like gold, the US Dollar, and other currencies on the back of the uncertainty created by this new communications strategy. While Powell may believe he can do more the keep markets calm now that every FOMC meeting will be followed by a press conference and Q&A, I think it’s more likely than not that we being to see measures of fear and uncertainty rising over the course of 2019. If that turns out to be the case, it will be a strong tailwind for risk-off assets like gold.
To sum up, I share the view of Pantheon Macroeconomics’ Ian Shepherdson who told Bloomberg, “Short of announcing that a rate cut is in the cards, this is about as dovish a statement as possible…Policy makers appear to be going all-in on the slowdown story.”
Equity markets are having their day in the sun extended a bit, but I think ultimately the Fed has set the stage for the end of the current rate-hike cycle and it’s introducing the possibility of increased macroeconomic uncertainty in a time where ambiguity is growing elsewhere within the US economy and abroad. That same uncertainty reminds us that nothing is a sure thing in markets, but does imply a return to a strong cycle for risk-off “safehaven” assets like gold and other precious metals.