Yesterday afternoon the Federal Reserve raised the cost of borrowing by 0.25% for the fourth and final time in 2018. With the target range moved up to 2.5%, rates are now at the bottom end of what the FOMC considers as the “neutral range” of 2.5-3.5%, meaning the era of technically accommodative Fed policy has ended. The debate now will turn to how soon monetary policy should be come “restrictive” to the growth of the US economy…if ever…if it hasn’t already.
The Fed Delivers a Dovish Hike and Roils Markets
Some 18 hours after the announcement and Chairman Powell’s Q&A that followed, it’s safe to say that investors and the markets have some feelings about this move. US equities plummeted on the news yesterday while bond prices rallied as investors fled riskier assets for the safety of government debt. The Fed had delivered on the “dovish hike” markets expected, but was not, it seems, dovish enough. The equity flight persisted through both Asia and European trading sessions over night and on Thursday morning, despite Dow and S&P futures being ever so slightly positive in pre-market trading, US stocks are still feeling the pain.
Also, 18 hours later, the price of gold has broken clean through the summer highs to trade north of $1260/oz with the next real level of resistance all the way up at $1300. As I’m sure you might have seen, it was not a straight line from Powell to $1260, however.
We’ll get back to that. First, let’s get back to the FOMC announcement.
Accompanying the FOMC’s statement and decision to raise rates was the committee’s Summary of Economic Projections (SEP) which alongside estimations of the neutral rate also includes the FOMC’s outlook on future growth and future interest rate hikes. It was in this data that the markets expected to see most of the “dovish” part of a dovish hike this month.
The projections were adjusted. The median mark for the Fed’s dot plot, which anonymously indicates where each member expects short-term rates to be in the next three years, has shifted down to foreseeing two hikes in 2019 vs. the three projected in the September SEP. The committee also made downward revisions to its median projection of US GDP growth in 2019 from 2.5% to now 2.3%.
The markets’ disappointment came in part from the projected number of hikes in 2019, which even after being revised down is still way above market expectations which today are barely pricing in a single rate hike over the next 12 months. The CME’s FedWatch tool is always a good way to track this: currently it projects less than 40% chance of a single hike by December 2019.
Another facet of the FOMC announcement that let markets down was the confirmation that the Fed will continue to let assets roll off it’s massive balance sheet as planned. Many investors, it seems, had hoped that if that Fed felt it had to hike rates even amid the “crosscurrents” Powell acknowledged have developed over the last quarter, then maybe they would at least slow the reduction of its balance sheet, which like interest rate hikes acts to tighten credit.
All in all, I think this was in fact a pretty cautiously dovish Fed Day. It feels like the monetary policy embodiment of Powell’s “dark room” analogy. But I also think it can be categorized as “cautiously optimistic.” Despite the revision for lower projected growth next year, Powell and the committee still feel optimistic about the US economy next year, and 2018 GDP is still projected to rise 3%-- the fastest since the GFC. This is a big reason for the Chairman and other FOMC voters pivoting the focus of their rhetoric to the “data dependent” nature of monetary policy moving forward—they’ve set the table for a possible pause in hiking rates for the time being, but should the growth outlook change they have the policy flexibility to pivot.
The equities markets did not agree with me, in a big, big way. Perhaps this is why I’m not an equities trader. The major US indices continued to absolutely plummet through Powell’s Q&A, ringing in the worst Fed Day performance for stocks since 2011.
Gold Price Action Following the Announcement
So why, in the name of Craig T. Nelson, is gold ALSO FALLING, the excitable trader in brain was screaming at the same time.
— FXStreet News (@FXstreetNews) December 19, 2018
It was a confusing move. Was the time-tested inverse correlation of risk/gold suddenly broken? Well, as of this morning I think we can safely say that those ties still bind, with gold rebounding all the way from a $1240 floor before Wednesday’s close to challenge the $1260/oz level.
My read on that odd US Dollar and gold action yesterday is this: it was the result of US political news that put a noisy bid into the dollar in spite of tumbling stocks. As I mentioned at the start of this week, one of the macro stories heading into Christmas would be the question of funding the federal government. Just as the FOMC’s afternoon was getting started, we started to see reports that congress had a very passable bill that will kick the can down the road (until February anyway) and I think that story was in the driver’s seat for the greenback yesterday and put a lot of pressure on gold spot, the Dollar’s opposite number. Once that heavy dollar-trading input was removed in the overnight sessions, we saw the strong bid in gold prices that we would have expected to correlate with yesterday’s other asset prices. For this reason, I think it’s possible that we could see a slight pullback in gold’s advance later today, either when the House (presumably) passes the Senate’s bill or if we get confirmation that the President will sign-off on it.
What’s Next for Gold Traders?
So, what are we watching going forward as gold traders? For me, there are two sources of information I want to keep an eye on in the immediate future. The first is commentary from other Fed members; it’s a safe bet today that we won’t see a rate hike in January and, in fact, that the recent pace of quarterly rate hikes is entirely on pause for now and so the markets will be looking for a suggestion of what comes next. Our best input for that between today and the release of the January meeting will be independent comments from fed officials. The second thing I will be tracking in the near term is sentiment in the US economy. Whether or not the actual participants in this economy continue to feel upbeat about it now and going forward to will be the strongest indicator of whether or not Wednesday’s rate hike was the right call or an unnecessarily restrictive one.
In the slightly more medium-term, I’ll also want to see how any indicators of economic growth trend, particularly in the US economy. As many pointed out, and Chairman Powell even re-iterated in his press conference, a big part of yesterday’s decision was based on the perceived strength of the American economy to date:
The case for not hiking:
- Inflation is mild
- Financial conditions have tightened considerably
- Interest rate sensitive sectors have been rolling over.
The case for hiking:
- The labor market is good, so why not?
- Equations and models
— Joe Weisenthal (@TheStalwart) December 19, 2018
Keep in mind though, there’s always a bit of a lag in US data. Sure, the most recent data indicated continued growth in our economy—but is our economy still growing right now?
As for gold prices, I think we can call the last twelve hours an official break in resistance at the $1250 mark and I’m not sure we’ll threaten that level again (which should now be a line of support) before Christmas as markets will be relatively calm through the holiday period. (Should be, anyway.) There’s a possibility of some last-minute before Christmas profit-taking on the heels of this breakout, but I don’t expect much.
And so, we head into the holiday period, and get set to take on the trading year 2019. Tomorrow, we’ll recap the week as a whole, and I’ll still be here through the next couple weeks letting you know how to mark your calendars.