Fed-ish Matters
We talk of Fed meeting minutes (probably the most important minutes on Earth!), jobs reports, inflation dragons, tapering fears and finally the glittery yellow metal that seduces.
Taper tantrum (beta version)
I wonder why the Fed releases minutes a month after the said meeting. These minutes get outdated quite fast given the pace of developments these days.
Anyway, the minutes of the 28-29 April meeting were released a few days ago. A lot of water has flowed under the bridge since that meeting- a surprisingly weak jobs report and a stronger-than-expected consumer inflation report, for example.
What scared markets was the prospect of tapering. Actually, what the minutes said was “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases”. It couldn’t have been more carefully worded yet the markets started getting tapering nightmares.
I think the Fed may discuss plans to taper its bond purchases in Q4 2021 and actually start reducing the pace of bond-buying in Q2 or Q3 2022. We still have a long way to go.
Where are the Jobs?
The Fed’s bond buying may be affected by the employment situation. And that is a bit dicey, after the disappointing April jobs report. Because even after March’s fab report, there is a long way to go before U.S. employment returns to normal. The unemployment rate may have fallen to 6 % but employment was 8.4 million jobs below its pre-pandemic level and that’s a far shot from the goal.
Hence with employment still below pre-pandemic levels and Covid still killing hundreds a day in the US, it is too early to even start talking of tapering. The Fed will be extremely careful not to slow a hard-won recovery which is now picking up pace.
The Genie of Inflation
The famous I word these days.
In the past, Powell and his choir at the Fed have repeatedly sung the same song- that this spring is expected to bring a “transitory” rise in inflation, mostly related to the reopening of the U.S. economy. That belief was repeated in the meeting minutes.
But while Lord Powell may believe what he says, the reality is a bit more complex. Let’s look at the Pros for and Cons against the Non Transient Inflation Theory (aka NTIT, an acronym I coined just now).
On the Pro side:
Recent surveys showed consumer expectations about future price increases were rising. That flies in the face of the Fed’s confidence that public attitudes about inflation were "well-anchored."
Prices of houses, semiconductor chips, cars etc. have soared.
Look at all the money out there’ scream some people. Surely that is inflationary?
On the Con side:
With the reopening, consumers are shifting away from goods towards services and the effect can be seen. Lumber corrected 30% in the last week (admittedly after a 220% rise in the last 12 months but Hey!). Copper is now starting to correct. The commodity price rise probably went too far too fast because many buyers panicked and ordered too much. This can destroy any fledgling inflation as businesses cancel these huge orders.
We haven’t seen any wage inflation yet. Wages are a big part of the basket and have stayed almost still for the last decade.
The genie of inflation has stubbornly refused to pop out of the inflation bottle over the past decade despite the enticements of many rounds of QE that pumped trillions of dollars into the economy.
The deflationary forces of technology, globalization, the gig economy, aging demographics etc. have screwed the cap of the inflation bottle firmly in place.
I think it’s too early to say whether inflation is transitory not. We need to wait and see whether inflation is broad-based and not just seen in a few items. We need to see the pace of reopening and the sorting of supply bottlenecks. All this will take at least a few quarters.
Talking Yellow
Gold is $1,880 per ounce today. The metal has risen by more than $190, or nearly 12%, since falling to a nine-month trough in early March. The rise was triggered by a fall in the value of the Greenback and a rise in inflation expectations, as bullion is seen as a hedge against inflation (more about that oddity below!).
Where is Gold headed for the rest of 2021? The frustrating (but appropriate) answer is ‘It depends’ because there are so many factors.
Gold can fall if yields and/or rates rise. Gold prices and the 10-year US Treasury yields share an inverse correlation. And so do Gold and interest rates. Higher Treasury yields are bearish for precious metals as investors can earn guaranteed returns from the yield unlike holding metals.
Gold can rise if the US dollar weakens and/or inflation rises because Gold is perceived as an inflation hedge.
But I must say that last bit is pure bullshit- the correlation between inflation and the price of gold is extremely weak & has been around 0.28 since 1971. If you look between 1978 and 1995 (which saw the highest rates of inflation since World War II) you’ll find that while the price of gold was extremely volatile (surging in the late 1970s and early 1980s only to fall back to earth in the mid-1980s and settling in the 1990s), the Consumer Price Index rose significantly more than gold during this period.
The next meeting of the Fed is in June where it will issue a new policy statement, update its projections for growth, inflation, unemployment, and the path of the benchmark rate. But nothing much will happen then.
Wait for September.